The weighted average cost of capital is the weighted average rate for the costs of the various sources of financing in an organization. These sources for Tudor Industries are as follows:

The short-term debt represents revolving credit, which is periodically renewed. Income taxes average 25%.

REQUIRED

A. Calculate the weighted average cost of capital (WACC) for Tudor Industries. If you need a formula, use a finance textbook or conduct an Internet search for “weighted average cost of capital.” One Web site providing a formula is: www.investopedia.com/terms/w/wacc.asp.

B. Explain how and why income taxes affect the calculation of WACC.

C. Discuss uncertainties about the best measure to use for the discount rate in a capital budgeting problem.

D. Discuss the pros and cons of using WACC as a discount rate in capital budgeting.

E. The market value for each source of capital is used when calculating WACC. Suppose you work for Tudor and need to calculate its WACC, but you do not know the market values.

Describe possible ways that you could estimate the market value for each of Tudor’s sources of capital.

F. Some people use financial statement book values to calculate WACC. Discuss reasons why this approach might result in an inappropriate value for WACC.

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Source of Capital Short-term debt Bonds Leases Common stock Market Value $300,000 900,000 200,000 900,000 Cost 8% 640 7% 10%