After careful analysis, Delta Inc., has determined that its optimal capital structure is composed of the sources

Question:

After careful analysis, Delta Inc., has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table.

Source of capitalTarget market value weight

Longterm debt.............................................30%

Preferred stock................................................15

Common stock equity........................................55

Total........................................................100%

The cost of debt is estimated to be 7.2 percent; the cost of preferred stock is estimated to be 13.5 percent; the cost of retained earnings is estimated to be 16.0 percent; and the cost of new common stock is estimated to be 18.0 percent. All of these are aftertax rates. The company's debt represents 25 percent, the preferred stock represents 10 percent, and the common stock equity represents 65 percent of total capital on the basis of 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 weights.

c. Compare the answers obtained in parts a and b. Explain the differences.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Cost Of Debt
The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to before-tax cost of debt, which is the company's cost of debt before taking...