Weighted average cost of capital (LO1) Sauer Milk, Inc. wants to determine the m

Question

Weighted average cost of capital (LO1) 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 5.0% 20% Preferred stock 10.0 10 Common equity 14.0 70 Plan B Debt 5.5% 30% Preferred stock 10.5 10 Common equity 15.0 60 Plan C Debt 6.0% 40% Preferred stock 10.7 10 Common equity 15.8 50 Plan D Debt 8.0% 50% Preferred stock 11.2 10 Common equity 17.5 40 a. Which of the four plans has the lowest weighted average cost of capital? (Round to two places to the right of decimal point.) b. Briefly discuss the results from Plan C and Plan D, and why one is better than the other.

Explanation / Answer

Plan B has the Lowest Avg Cost of Capital

Plan C is Better than Plan D because it has Lower Avg Cost of Capital

Particulars Cost of capital(%) Weights Total Plan A Equity 14 0.7 9.8 Debt 5 0.2 1 Preferred Equity 10 0.1 1 Total Cost of Capital 11.8 Plan B Equity 15 0.6 9 Debt 5.5 0.3 1.65 Preferred Equity 10.5 0.1 1.05 Total Cost of Capital 11.7 Plan C Equity 15.8 0.5 7.9 Debt 6 0.4 2.4 Preferred Equity 10.7 0.1 1.07 Total Cost of Capital 11.37 Plan D Equity 17.5 0.4 7 Debt 8 0.5 4 Preferred Equity 11.2 0.1 1.12 Total Cost of Capital 12.12

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