Weighted Average Cost of Capital You are part of a team that is planning to present to the strategic planning and investment committee your companys weighted average cost of capital. You plan in discussing the appropriate weights, how the WACC is used in capital budgeting and in corporate valuation, and any adjustments or other factors that could impact the overall cost of capital. The company utilizes three forms of capital in funding projects. Your job is to estimate the effective cost of each and then to calculate the companys weighted average cost of capital. Below is useful data that will help you in your analysis: Current 10-year treasury rate = 2.75% Current Market Risk Premium = 7.5% Companys debt is rated A. A rated debt usually carries a 0.50% -0.75% premium to comparable treasuries Bond Data: The company has one annual interest coupon bonds that are traded in the market. The bond has a 3.0% coupon and is currently priced at $975. The bond matures in 10 years and has a face of $1000. The companys tax rate is 25%. Preferred Data The company has outstanding preferred stock that has a 6% coupon and matures in 100 years. It is not callable. The par value is $25, and it currently sells for $28. If they were to sell additional preferred, they would incur flotation costs of 10%.

Common Stock The companys beta = 0.7. The current stock price is $50 and the expected dividend next year D(1) = $2.00. It is expected that the dividend will grow at a constant rate of 4% indefinitely. Questions 1- Using a target capital structure of 30% debt, 60% common stock and 10% preferred, what is the weighted average cost of capital that will be used to assess new projects? For this problem assume that all common stock is raised as retained earnings and that any additional debt that is used will be 0.5% above the companys current long-term cost of borrowing. 2- Using the same target capital structure, recalculate the WACC, assuming that there are no retained earnings, and that new common equity issuance will incur a flotation cost of 15%. Only reconfigure your cost of equity using the market implied cost of equity method (do not use the CAPM) and keep other component costs the same.