WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table: The cost of debt is estimated to be 4.5%, the cost of preferred stock is estimated to be 11.8%; the cost of retained earnings is estimated to be 15.3%, and the cost of new common stock is estimated to be 17.3%. All of these are after-tax rates. The company's debt represents 22%, the preferred stock represents 10%, and the common stock equity represents 68% 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. a. The weighted average cost of capital on the basis of historical market value weights is %. (Round to two decimal places.) b. The weighted average cost of capital on the basis of target market value weights is %. (Round to two decimal places.) c. Compare the answers obtained in parts a and b. Explain the differences. (Select the best answer below.) O A. Using historical weights, the firm has a higher cost of capital due to the weighting of the more expensive common stock component, 68%, versus the target weight of 58%. B. Using historical weights, the firm has a lower cost of capital because historical costs are often lower than future expected costs. OC. Using historical weights, the firm has a higher cost of capital because historical costs are often higher than future expected costs. OD. Using historical weights, the firm has a lower cost of capital due to the weighting of the more expensive common stock component, 68%, versus the target weight of 58%. WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table: The cost of debt is estimated to be 4.5%, the cost of preferred stock is estimated to be 11.8%; the cost of retained earnings is estimated to be 15.3%, and the cost of new common stock is estimated to be 17.3%. All of these are after-tax rates. The company's debt represents 22%, the preferred stock represents 10%, and the common stock equity represents 68% 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. Data Table a. The weighted average cost of capital on the basis of historical market value weights is %. (Round to two decimal places.) b. The weighted average cost of capital on the basis of target market value weights is %. (Round to two decimal places.) (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) c. Compare the answers obtained in parts a and b. Explain the differences. (Select the best answer below.) Target market value weight 27% A. Using historical weights, the firm has a higher cost of capital due to the weighting of the more expensive common stock component, 68%, versus the target weight of 58%. B. Using historical weights, the firm has a lower cost of capital because historical costs are often lower than future expected costs. O C. Using historical weights, the firm has a higher cost of capital because historical costs are often higher than future expected costs. OD. Using historical weights, the firm has a lower cost of capital due to the weighting of the more expensive common stock component, 68%, versus the target weight of 58%. Source of capital Long-term debt Preferred stock Common stock equity Total 15 58 100% Print Done