(%) P9-15 (similar to) Question Help WACC and target weights After careful analy
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(%) P9-15 (similar to) Question Help WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table: EE9 The cost of debt is estimated to be 7.5%, the cost of preferred stock is estimated to be 14.3%; the cost of retained earnings is estimated to be 16.8%; and the cost of new common stock is estimated to be 18.8%. All of these are after-tax rates. The company's debt represents 25%, the preferred stock represents 9%, and the common stock equity represents 66% of total capital on the basis o the market values of the three components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common stock. a. Calculate the weighted average cost of capital on the basis of historical market value weights b. Calculate the weighted average cost of capital on the basis of target market value woights. c. Compare the answers obtained in parts a and b. Explain the differences (Round to two decimal places.) Data Table (Click on the icon located copy its contents into a spreadsheet.) on the top-right corner of the data table below in order to Target market value weight Source of capital Long-term debt Preferred stock Common stock equity Total 30% 56 100% Print Done Enter your answer in the answer box and then click Check Answer Clear All Check Answer remainingExplanation / Answer
Historical market value weights:
WACC=25%*7.5%+9%*14.3%+66%*16.8%=14.25%
Target market value weights:
WACC=30%*7.5%+14%*14.3%+56%*16.8%=13.66%
Difference arises because they are planning to reduce equity (which has higher cost) which is captured in target but not historical hence historical WACC is higher
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