Essay About Average Cost Of Capital And Weight Of Debt

Financial
FINALS:Mark Tool has on its books the amount and specific (after-tax) costs shown in the following table for each source of capital.Source of CapitalBook ValueSpecific CostLong-Term Debt$ 700, 0005.3%Preferred Stock50, 00012.0Common Stock Equity650, 00016.0Calculate the firm’s weighted average cost of capital using book value weights.Explain how the firm can use this cost in the investment decision-making process.WACC = Equity proportion * Cost of equity + Debt proportion * Cost of debt * (1-Tax) So in you case it would be:  A. wacc = 700,000/1400,000*0.053+50,000/1400,000*0.12+650,000/1400,000*0.16 = 10.51% B.Investment decision should depend on IRR of the project. If IRR is higher than WACC, such investment should be completed.Peter Company has compiled the information shown in the following table.Source of CapitalBook ValueMarket ValueAfter-Tax costLong-Term Debt$ 4, 000, 000$ 3, 840, 0006.0%Preferred Stock40, 00060, 00013.0Common Stock Equity1, 060, 0003, 000, 00017.0Total$ 5, 100, 000$ 6, 900, 000Calculate the weighted average cost of capital using book value weights.Calculate the weighted average cost of capital using market value weights.Compare the answers obtained in a and b.  Explain the differences.Book values Weight of debt = 4m/5.1m = 78.43% Weight of pref stock = 40000/5.1m= 0.7843% Weight of common stock = 1060000/5.1m = 20.78%, these should sum to 100% a) Book values = (78.43% * 6%) + (0.7843% * 13%) + (20.78% * 17%) = 8.34% b) market values Weight of debt = 3.84m/6.9m = 55.65% Weight of pref stock = 60000/6.9m= 0.8696% Weight of common stock = 3m/6.9m = 43.48%, these should sum to 100%