8. Westerly Manufacturing has compiled the information shown in the following ta

Question

8. Westerly Manufacturing has compiled the information shown in the following table:

Source of Capital Book Value Market Value After-tax Cost
Long-Term Debt $4,000,000 $3,840,000 6.0%
Preferred Stock $40,000 $60,000 13.0%
Common Stock Equity $1,060,000 $3,000,000 17.0%
Totals $5,100,000 $6,900,000

(a) Calculate the firm’s weighted average cost of capital (WACC) using book value weights.
(b) Calculate the firm’s weighted average cost of capital (WACC) using market value weights.
(c) Compare your answers found in parts (a) and (b) and briefly explain the differences. Other things equal, would you recommend that Westerly Manufacturing rely on its book value weights or market value weights in determining its WACC?

Explanation / Answer

Component cost of debt Coupon rate 10.25% Periods/year 2 Maturity (yr) 15 Bond price $1,025.00 Par value $1,000 Tax rate 40% Calculator inputs: N = 2 ? 15 30 PV = Bond's price -$1,025.00 PMT = coupon rate * par/2 $51.25 FV = Par = Maturity value $1,000 I/YR 4.96% times periods/yr = before-tax cost of debt 9.93% = After-tax cost of debt (A-T rd) for use in WACC 5.96%

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