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Promo Pak has compiled the following financial data: Source of Capital Book Valu

ID: 2783690 • Letter: P

Question

Promo Pak has compiled the following financial data:

Source of Capital               Book Value      Market Value     Cost

Long-term debt                $ 8,000,000     $ 8,500,000          5.0%

Preferred stock                       500,000            750,000         12.0

Common stock equity          9,000,000      15,000,000         16.0

                                            ------------         ------------

                                          $17,500,000    $24,250,000

a.   Calculate the weighted average cost of capital using book value weights.

b.   Calculate the weighted average cost of capital using market value weights.

Explanation / Answer

Computation of weights of Book Value

Particulars

Book Value

%

Long-term debt   

$               8,000,000

46%

Preferred stock

$                   500,000

3%

Common stock equity

$               9,000,000

51%

Total

$            17,500,000

100%

Computation of Weights of Market Value

Particulars

Market Value  

%

Long-term debt   

$               8,500,000

35%

Preferred stock

$                   750,000

3%

Common stock equity

$            15,000,000

62%

Total

$            24,250,000

100%

a.   Calculate the weighted average cost of capital using book value weights.

Ke= (Wd x Kd) +( Wp x Kp) +(We x Ke)

    =(46% x 5%) +( 3% x 12%) +(51%x 16%)

=2.29% +0.34% + 8.23%

=10.86%

b.   Calculate the weighted average cost of capital using market value weights.

Ke= (Wd x Kd) +( Wp x Kp) +(We x Ke)

    =(35% x 5%) +( 3% x 12%) +(62%x 16%)

=1.75% +0.37% + 9.90%

=12.02%

Computation of weights of Book Value

Particulars

Book Value

%

Long-term debt   

$               8,000,000

46%

Preferred stock

$                   500,000

3%

Common stock equity

$               9,000,000

51%

Total

$            17,500,000

100%