Billy Bob’s capital structure consists of 20 percent debt, 30 percent preferred

ID: 2782169 • Letter: B

Question

Billy Bob’s

capital structure consists of 20 percent debt, 30 percent preferred stock,

and 50

percent common stock. If the firm

raises new capital, its after

tax cost of debt will

be 3.5 percent, it

s cost of preferred stock will be 6 percent, its cost of retained earnings

will be 10.2 percent, and its cost of new common equity

will be 12.4 percent. If Billy

Bob’s

needs to raise $220,000 and it expects to generate $100,000 in retained earnings

this ye

ar, what is its marginal cost of capital to raise the needed funds?

WACC = wd x kd + we x ke + wps x kps

Here, w - weight, k - cost, d - debt, e - equity and ps - preferred stock

For marginal cost of capital, we take marginal cost of debt and equity

WACC = 20% x 3.5% + 30% x 6% + 50% x 12.4%

= 8.7%

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