GHJ Inc.is investing in a major capital budgeting project that will require the expenditure of $16 million.The money will be raised by issuing $2 million of bonds,$4 million of preferred stock,and $10 million of new common stock.The company estimates is after-tax cost of debt to be 7%,its cost of preferred stock to be 9%,the cost of retained earnings to be 14%,and the cost of new common stock to be 17%.What is the weighted average cost of capital for this project?

Question

Quizplus · Accepted Answer

To calculate the weighted average cost of capital (WACC), we must first calculate the cost of each source of financing and then weight each cost by the proportion of financing that each source represents.

Cost of debt = 7% * (1 - 0.30) = 4.9% (assuming a 30% tax rate)
Cost of preferred stock = 9%
Cost of retained earnings = 14%
Cost of new common stock = 17%

Weight of debt = $2 million / $16 million = 0.125
Weight of preferred stock = $4 million / $16 million = 0.25
Weight of retained earnings = $0 million / $16 million = 0
Weight of new common stock = $10 million / $16 million = 0.625

WACC = (0.125 * 4.9%) + (0.25 * 9%) + (0 * 14%) + (0.625 * 17%) = 13.75%

Therefore, the best choice is C.

GHJ IncIs Investing in a Major Capital Budgeting Project That Will