Question
WACC Book weights and market weights. Webster Company has compiled the information shown in the following table: Source of capital Book value Market value After-tax
WACCBook weights and market weights. Webster Company has compiled the information shown in the following table:
Source of capital | Book value | Market value | After-tax cost | |||
Long-term debt | $4,000,000 | $3,840,000 | 7% | |||
Preferred stock | 40,000 | 54,000 | 11% | |||
Common stock equity | 1,060,000 | 3,784,000 | 14% | |||
Totals | $5,100,000 | $7,678,000 |
a.Calculate the weighted average cost of capital using book value
weights.
b.Calculate the weighted average cost of capital using market value
weights.
c.Compare the answers obtained in parts a and b. Explain the differences
Answer the following:
a.The firm's weighted average cost of capital using book value weights is __% (Round to two decimal places.)
b.The firm's weighted average cost of capital using 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.)
a) The book value approach yields a lower cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a higher value than its market value, the cost of capital is much higher when using the book value weights.
b) The market value approach yields a higher cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a higher value than its book value, the cost of capital is much higher when using the market value weights.
c) The market value approach yields a lower cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a lower value than its book value, the cost of capital is much lower when using the market value weights.
d) The book value approach yields a higher cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a lower value than its market value, the cost of capital is much higher when using the book value weights.
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