The weighted average cost of capital $($WACC$)$ is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is an appropriate discount rate only for a project of average risk.

Consider the case of Turnbull Company:

Turnbull Company has a target capital structure of $45\%$ debt, $4\%$ preferred stock, and $51\%$ common equity. It has a before$-$tax cost of debt of $11\mathrm{.}10\%,$ and its cost of preferred stock is $12\mathrm{.}20\%.$ If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be $14\mathrm{.}70\%.$ However, if it is necessary to raise new common equity, it will carry a cost of $16\mathrm{.}80\%.$

If its current tax rate is $40\%,$ Turnbull$$s weighted average cost of capital $($WACC$)$ will be higher if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings.

Turnbull Company is considering a project that requires an initial investment of $$1,708,000\mathrm{.}00.$ The firm will raise the $$1,708,000\mathrm{.}00$ in capital by issuing $$750,000\mathrm{.}00$ of debt at a before$-$tax cost of $8\mathrm{.}70\%,$ $$78,000\mathrm{.}00$ of preferred stock at a cost of $9\mathrm{.}90\%,$ and $$880,000\mathrm{.}00$ of equity at a cost of $13\mathrm{.}20\%.$ The firm faces a tax rate of $40\%.$ The WACC for this project is