Evans Technology has the following capital structure. The aftertax cost of debt

Question

Evans Technology has the following capital structure.

The aftertax cost of debt is 8.00 percent; and the cost of common equity (in the form of retained earnings) is 15.00 percent.

What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

An outside consultant has suggested that because debt is cheaper than equity, the firm should switch to a capital structure that is 50 percent debt and 50 percent equity.

Under this new and more debt-oriented arrangement, the aftertax cost of debt is 9.00 percent, and the cost of common equity (in the form of retained earnings) is 17.00 percent.

Recalculate the firm's weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Evans Technology has the following capital structure.

Explanation / Answer

a. Plan A

Weighted average cost of capital

Ke * weight + After tax Kd * Weight = 15% * 0.65 + 8% * 0.35 = 12.55%

b. Plan B

Weighted average cost of capital

Ke * weight + After tax Kd * Weight = 17% * 0.50 + 9% * 0.50 = 13.00%

c. Plan A is optimal in terms of minimizing the weighted average cost of capital because it has WACC of 12.55% than Plan B of 13.00%

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