Calculating WACC
James Corporation has compiled the following information on its financing costs:
Type of Financing Book Value ($) Market Value ($) Cost (%)
Long term debt 5,000,000 2,000,000 10
Short term debt 5,000,000 5,000,000 8
Common stock 10,000,000 13,000,000 15
Total $20,000,000 20,000,000
The cost of debt in the above table is pre-tax.
James is in the 34 percent tax bracket and has a target debt-to-equity ratio of 100 percent.
James’s managers would like to keep the market values of short term and long term debt equal.
Calculate the after tax weighted average cost of capital (WACC) for James using:
a. Book – value weights
b. Market – value weights
c. Target weights
My attempts are as follows:
A. Book – value weights
Type of
Financing Book
Value ($) Before-tax
Cost of Debt After-tax
Cost of Debt Proportion Weighted Cost
Long term debt 5,000,000 0.10 0.066 0.25 0.0165
Short term debt 5,000,000 0.08 0.0528 0.25 0.0132
Common Stock 10,000,000 0.15 0.15 0.50 0.075
Total 20,000,000 0.1047
WACC 10.47%
B. Market – value weights
Type of
Financing Market
Value ($) Before-tax
Cost of Debt After-tax
Cost of Debt Proportion WeightedCost
Long term debt 2,000,000 0.10 0.066 0.10 0.0066
Short term debt 5,000,000 0.08 0.0528 0.25 0.0132
Common Stock 13,000,000 0.15 0.15 0.65 0.0975
Total 20,000,000 0.1173
WACC 11.73%
C. Target - value weigths
Equity 33 / 2 = 16.5 %
debt = 16.5%
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