Solving for the WACC The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is only an appropriate discount rate for a project of average risk-in other words, a projectthat has the same beta as the company. If a project has less risk than the overall company risk, it should beevaluated with a lower discount rate; if a project is riskier than the overall company risk, it should be evaluated usinga discount rate higher than the company WACC. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has abefore-tax cost of debt of 8.2%, and its cost of preferredstock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%.However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 40%, how much higher will Turnbull's weighted average cost of capital (WACC) be ifit has to raise additional common equity capital byissuing new common stock instead of raising the fundsthrough retained earnings? 0.92% 1.06% 0.78% 1.15% Consider the case of Jordan Co. Jordan Co.'s CFO is trying to determine the company's WACC. He has determined that the company's before-tax cost of debt is 10.2%. The company currently has $750,000 of debt, and the CFO believes that the book value of thecompany's debt is a good approximation for the market value of the company's debt. The firm's cost of preferred stock is 11.4%, and the book value of preferred stock is $45,000. Its cost of equity is 14.3%, and the company currently has $500,000 of common equity on its balance sheet. The CFO has estimated that the firm's market value of preferred stock is $78,000, and the market value of itscommon equity is $880,000. Determine Jordan's WACC if it is subject to a tax rate of 40%. Consider the case of Kuhn Co. Kuhn Co. is considering a new project that will require an initial investment of $45 million. It has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. Kuhn has noncallable bonds outstanding thatmature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1, 555.38. Theyield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. Thecompany can sell shares of preferred stock that pay an annual dividend of $8 at a price of $92.25 per share. You canassume that Jordan does not incur any flotation costs when issuing debt and preferred stock. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay adividend of $1.36 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing newcommon stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 40%.Determine what Kuhn Company's WACC will be for this project
