Question

Bartlett Company's target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using reinvested earnings is 12.75%. The firm will not be issuing any new stock. You were hired as a consultant to help determine their cost of capital. What is its WACC?a. 8.98%b. 9.26%c. 9.54%d. 9.83%e. 10.12%.

Answer 1

Explanation:

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Answer 2

Answer:

The answer is b. 9.26%

Explanation:

The capital structure of a company consists mainly of debt and equity. In this question, preferred stock (a mixture of debt and equity), is introduced to the capital structure. The Weighted Average Cost of Capital (WACC) is a calculation that is carried out to evaluate the profitability of a company by investors or creditors. It depicts the ability of a company to generate cash flows needed to pay debt or distribute returns to their shareholders. The management of a company can also use this calculation to determine how purchasing assets or embarking on a project financed by debt or equity will impact the profitability of a company or its share price.

The calculation of WACC is carried out as follows:

E/V*Re + D/V*Rd *(1-T) where:

• E is market value of equity
• D is the market value of debt
• Re is the cost of equity
• Rd is the cost of debt
• V: is the total market value of financing, that is E + D
• E/V: percentage of financing that is from equity
• T: corporate tax rate

• D/V: percentage of financing that is from debt

From this formula, the computation of WACC is conducted as follows:

The cost of equity: 0.45 * 12.75% = 5.7375%

The cost of debt: 0.4 * 6.00% = 2.4%

The cost of preferred: 0.15 * 7.50% = 1.125%

WACC = 5.7375% + 2.4% + 1.125% = 9.2625%