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?

Question

Business

Finn Bowen

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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Answers (1)

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Annabel Berg · Answer 1

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%