Question

The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 7 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 9.5 percent. The aftertax cost of debt is 4.8 percent, the cost of preferred is 8.9 percent, and the cost of common stock is 14.7 percent. What percentage of the firm's capital funding should be debt financing?a. 44.78 percentb. 54.15 percentc. 52.03 percentd. 48.42 percente. 39.21 percent

Answer 1

Answer:

Weight of debt, Wd = 0.4842 or 48.42%

Explanation:

WACC = Wd×Rd×(1-t)+We×Ke+Wp×Kp

W is weights of respective portfolios

R is return on respective portfolios

Wd+We+Wp = 1

9.50% = Wd×4.80%+(0.93-Wd)×14.70%+0.07×8.90%

9.5% = Wd×4.80%+13.671%-14.70%×Wd+0.623%

9.90%×Wd = 4.794%

Weight of debt, Wd = 0.4842 or 48.42%