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P9–13WACC—Book weightsRidge Tool has on its books the amounts and specific(after-tax) costs shown in the following table for each source of capital.PART 4Risk and the Required Rate of ReturnLG6Source of capitalBook valueIndividual costLong-term debt$700,0005.3%Preferred stock50,00012.0Common stock equity650,00016.0Source of capitalBook valueMarket valueAfter-tax costLong-term debt$4,000,000$3,840,0006.0%Preferred stock40,00060,00013.0Common stock equity17.0Totals$6,900,000$5,100,0003,000,0001,060,000Target marketSource of capitalvalue weightLong-term debt30%Preferred stock15Common stock equityTotal%10055a.Calculate the firm’s weighted average cost of capital using book value weightsb.Explain how the firm can use this cost in the investment decision-makingprocess.P9–14WACC—Book weights and market weightsWebster Company has compiled theinformation shown in the following table.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 aand b.Explain the differences.P9–15WACC and target weightsAfter careful analysis, Dexter Brothers has determinedthat its optimal capital structure is composed of the sources and target market valueweights shown in the following table.The cost of debt is estimated to be 7.2%; the cost of preferred stock is estimated tobe 13.5%; the cost of retained earnings is estimated to be 16.0%; and the cost ofnew common stock is estimated to be 18.0%. All of these are after-tax rates. Thecompany’s debt represents 25%, the preferred stock represents 10%, and thecommon stock equity represents 65% of total capital on the basis of the marketvalues of the three components. The company expects to have a significant amountof retained earnings available and does not expect to sell any new common stock.LG6LG6380.
a.Calculate the weighted average cost of capital on the basis of historical marketvalue weights.b.Calculate the weighted average cost of capital on the basis of target market valueweights.c.Compare the answers obtained in parts aandb.Explain the differences.P9–16Cost of capitalEdna Recording Studios, Inc., reported earnings available tocommon stock of $4,200,000 last year. From those earnings, the company paid adividend of $1.26 on each of its 1,000,000 common shares outstanding. The capitalstructure of the company includes 40% debt, 10% preferred stock, and 50%common stock. It is taxed at a rate of 40%.a.If the market price of the common stock is $40 and dividends are expected togrow at a rate of 6% per year for the foreseeable future, what is the company’scost of retained earningsfinancing?b.If underpricing and flotation costs on new shares of common stock amount to$7.00 per share, what is the company’s cost of new common stockfinancing?c.The company can issue $2.00 dividend preferred stock for a market price of$25.00 per share. Flotation costs would amount to $3.00 per share. What is thecost of preferred stockfinancing?d.The company can issue $1,000-par-value, 10% coupon, 5-year bonds that can besold for $1,200 each. Flotation costs would amount to $25.00 per bond. Use the