Question

GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of​ $16 million. The money will be raised by issuing​ $2 million of​ bonds, $4 million of preferred​ stock, and​ $10 million of new common stock. The company estimates is afterminustax cost of debt to be​ 7%, its cost of preferred stock to be​ 9%, the cost of retained earnings to be​ 14%, and the cost of new common stock to be​ 17%. What is the weighted average cost of capital for this​ project?

Answer 1

Answer:

13.75%

Explanation:

Data provided in the question:

Total expenditure = $16 million

Debt = $2 million

Preferred​ stock = $4 million

Common stock = $10 million

After-tax cost of debt =​ 7% = 0.07

Cost of preferred stock =​ 9% = 0.09

Cost of retained earnings =​ 14%

Cost of new common stock =​ 17%

Now,

Weight of debt = $2 million ÷ $16 million

= 0.125

Weight Cost of preferred stock = $4 million ÷ $16 million

= 0.25

Weight Cost of new common stock = $10 million ÷ $16 million

= 0.625

The weighted average cost of capital for this​ project

= ( 0.07 × 0.125 ) + ( 0.09 × 0.25 ) + ( 0.17 × 0.625)

= 0.00875 + 0.0225 + 0.10625

= 0.1375

or

= 0.1375 × 100%

= 13.75%