Question
WACC and target weights After carefulanalysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights
WACC and target weightsAfter carefulanalysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the followingtable:
Source of capital target market value weight
Long-term debt
25%
Preferred stock
11%
Common stock equity
64%
Total
100%
The cost of debt is estimated to be 4.5%; the cost of preferred stock is estimated to be 10.9%; the cost of retained earnings is estimated to be 14.4%; and the cost of new common stock is estimated to be 16.4%. All of these areafter-tax rates. Thecompany's debt represents 20%, the preferred stock represents 6%, and the common stock equity represents 74% 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.
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