Bartlett Company's target capital structure is 40% debt, 15% preferred, and 45% common equity The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using retained earnings is 12.75% The firm will not be issuing any new stock You were hired as a consultant to help determine their cost of capitalWhat is its WACC?

Question

Quizplus · Accepted Answer

Step 1: Calculate the weights of each component.

Debt: 40%
Preferred: 15%
Common Equity: 45%

Step 2: Calculate the cost of each component.

Debt: 6.00%
Preferred: 7.50%
Common Equity: 12.75%

Step 3: Calculate the cost of equity using the CAPM model.

Using the CAPM model: Cost of Equity = Risk-Free Rate + Beta(Cost of Market Return - Risk-Free Rate)
Assuming the risk-free rate is 2.5%, the beta is 1.2, and the market return is 9%, we get:
Cost of Equity = 2.5% + 1.2(9% - 2.5%)
Cost of Equity = 11.3%

Step 4: Calculate the weighted average cost of capital (WACC).

WACC = (Weight of Debt * Cost of Debt) + (Weight of Preferred * Cost of Preferred) + (Weight of Equity * Cost of Equity)
WACC = (0.40 * 6.00%) + (0.15 * 7.50%) + (0.45 * 11.3%)
WACC = 9.26%

Therefore, the answer is B.

Bartlett Company's Target Capital Structure Is 40% Debt, 15% Preferred