Question

Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans: Cost (aftertax) Weights Plan A Debt 3.0 % 15 % Preferred stock 6.0 10 Common equity 10.0 75 Plan B Debt 3.2 % 25 % Preferred stock 6.2 10 Common equity 11.0 65 Plan C Debt 4.0 % 35 % Preferred stock 6.7 10 Common equity 10.6 55 Plan D Debt 7.0 % 45 % Preferred stock 7.6 10 Common equity 12.6 45 a-1. Compute the weighted average cost for four plans.

Answer 1

Answer:

Plan A = 8.55%

Plan A =8.57%

Plan A =7.9%

Plan A =6.58%

Explanation:

The weighted average cost of capital can be computed by multiplying the Cost of capital (after tax) with the weights. The weighted average cost for four plans are as follows

WACC = Cost of capital x Weights

PLAN A

                                Weights      Cost of capital      WACC

Debt                         3.0 %                    15 %                0.45%    

Preferred stock       6.0                        10%                0.6%

Common equity      10.0                      75%               7.5%

WACC                                                                          8.55%

PLAN B

                                Weights      Cost of capital      WACC

Debt                         3.2 %                  25%                0.8%    

Preferred stock       6.2                      10%                0.62%

Common equity      11.0                      65%               7.15%

WACC                                                                         8.57%

PLAN C

                                Weights      Cost of capital      WACC

Debt                          4.0 %                   35 %                1.4%    

Preferred stock        6.7                        10%                0.67%

Common equity       10.6                      55%               5.83%

WACC                                                                          7.90%

PLAN D

                                Weights      Cost of capital      WACC

Debt                         7.0 %                   45 %                3.15%    

Preferred stock       7.6                       10%                 0.76%

Common equity       12.6                     45%                5.67%

WACC                                                                          6.58%