90.2K

Verified Solution

Link Copied!

Solving for a firm's WACC

A firm's weighted average cost of capital $($WACC$)$ is used as the discount rate to evaluate various capital budgeting projects. However, remember the

WACC is an appropriate discount rate only for a project of average risk.

Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address.

The case of Cute Camel Woodcraft Company

Cute Camel Woodcraft Company has a target capital structure of $58\%$ debt, $6\%$ preferred stock, and $36\%$ common equity. It has a before$-$tax cost of

debt of $11\mathrm{.}1\%,$ and its cost of preferred stock is $12\mathrm{.}2\%.$

If Cute Camel can raise all of its equity capital from retained earnings, its cost of common equity will be $14\mathrm{.}7\%.$ However, if it is necessary to raise

new common equity, it will carry a cost of $16\mathrm{.}8\%.$

If its current tax rate is $40\%,$ how much higher will Cute Camel's weighted average cost of capital $($WACC$)$ be if it has to raise additional common

equity capital by issuing new common stock instead of raising the funds through retained earnings? $($Note: Round your answer to two decimal places.$)$

$0\mathrm{.}28\%$

$0\mathrm{.}75\%$

$0\mathrm{.}90\%$

$0\mathrm{.}94\%$

The case of Purple Lemon Shipbuilders

The CFO of Purple Lemon Shipbuilders is trying to determine the company's WACC. He has determined that the company's before$-$tax cost of debt is

$9\mathrm{.}60\%.$ The company currently has $$750,000$ of debt, and the CFO believes that the book value of the company's debt is a good approximation for the

market value of the company's debt.

Answer & Explanation Solved by verified expert

See Answer