As president of Madison Corp. your finance people tell you that Madison is 30% d
ID: 2744815 • Letter: A
Question
As president of Madison Corp. your finance people tell you that Madison is 30% debt and 70% common stock. In addition they tell you the cost of the common stock is 11% and the cost of the debt is 5.0%. What is Madison’s weighted average cost of capital? (round at 2 decimal places)
(The bottom part is the actual question, but you needed this top part)
Using the information is the previous problem, the president suggest that Madison take on more debt in the future to finance additional positive net present value projects. She estimates that a 60% debt and 40% equity mixture for the entire corporation is better. If Madison adopts this new debt oriented structure the cost of equity will increase to 14% and the cost of debt will increase to 7.0%. Please recalculate and report the new weighted average cost of capital and determine if Madison should stay where it is or adopt the higher debt oriented capital structure? (round at 2 decimal places)
Explanation / Answer
WEIGHTED AVERAGE COST OF CAPITA
= WEIGHT * COST OF DEBT + WEIGHT * COST OF COMMON STOCK
= 0.30 * 5% + 0.70 * 11%
= 1.50% + 7.70%
= 9.20%
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WEIGHTED COST OF PAITAL FOR HIGHER DEBT ORINTED OPTION
= WEIGHT * COST OF DEBT + WEIGHT * COST OF COMMON STOCK
= 0.60 * 7% + 0.40 * 14%
= 4.20% + 5.60%
= 9.80%
DECESSION:-
MADISON SHOULD WHERE IT IS, NEW WEIGHTED AVERAGE COST OF CAPITAL IS MORE COSTLIER THAN THE OLD ONE.
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