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28 October, 14:00

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 afterminustax 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?

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  1. 28 October, 15:25
    0
    13.75%

    Explanation:

    Data provided in the question:

    Total expenditure = $16 million

    Debt = $2 million

    Preferred stock = $4 million

    Common stock = $10 million

    After-tax cost of debt = 7% = 0.07

    Cost of preferred stock = 9% = 0.09

    Cost of retained earnings = 14%

    Cost of new common stock = 17%

    Now,

    Weight of debt = $2 million : $16 million

    = 0.125

    Weight Cost of preferred stock = $4 million : $16 million

    = 0.25

    Weight Cost of new common stock = $10 million : $16 million

    = 0.625

    The weighted average cost of capital for this project

    = (0.07 * 0.125) + (0.09 * 0.25) + (0.17 * 0.625)

    = 0.00875 + 0.0225 + 0.10625

    = 0.1375

    or

    = 0.1375 * 100%

    = 13.75%
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