Read Gitman and Zutter, Chapters 7-10, reviewing those chapters already assigned
ID: 2778851 • Letter: R
Question
Read Gitman and Zutter, Chapters 7-10, reviewing those chapters already assigned, and prepare written responses to the following problem:
Two companies, TimCo., Inc. and MitCo., Inc. have the identical cost for each individual element of their capital. Calculate the overall WACC for each company and analysis why there is a difference in the WACC.
TimCo, Inc.
Type of Capital
Book Value
Cost
Long-Term Debt
$500,000
6.20%
Common Stock Equity
$400,000
15.00%
Preferred Stock
$75,000
13.00%
MitCo, Inc.
Type of Capital
Book Value
Cost
Long-Term Debt
$450,000
6.20%
Common Stock Equity
$500,000
15.00%
Preferred Stock
$60,000
13.00%
TimCo, Inc.
Type of Capital
Book Value
Cost
Long-Term Debt
$500,000
6.20%
Common Stock Equity
$400,000
15.00%
Preferred Stock
$75,000
13.00%
MitCo, Inc.
Type of Capital
Book Value
Cost
Long-Term Debt
$450,000
6.20%
Common Stock Equity
$500,000
15.00%
Preferred Stock
$60,000
13.00%
Explanation / Answer
TimCo, Inc.
Weight of Debt = 500000/(500000+400000+75000) = 0.512821
Weight of Common Stock = 400000/(500000+400000+75000) = 0.410256
Weight of Preferred Stock = 75000/(500000+400000+75000) = 0.076923
WACC = Weight of Debt* After Tax cost of Debt + Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock
WACC = 0.512821*6.2 + 0.410256 * 15+ 0.076923 * 13
WACC = 10.33%
MitCo, Inc.
Weight of Debt = 450000/(450000+500000+60000) = 0.445544
Weight of Common Stock = 500000/(450000+500000+60000) = 0.49505
Weight of Preferred Stock = 60000/(450000+500000+60000) = 0.059406
WACC = Weight of Debt* After Tax cost of Debt + Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock
WACC = 0.445544*6.2 + 0.49505 * 15+ 0.059406 * 13
WACC = 10.96%
There is a difference in the WACC because of Capital structure .
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