Determine the weighted cost of capital for the Mills Company that will finance its optimal capital budget with $120 million of long-term debt (kd = 12.5%) and $180 million in retained earnings (ke = 16.0%). Mills' present capital structure is considered optimal. The company's marginal tax rate is 40%.

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Business

Elise Mendoza

15 November, 16:50

Determine the weighted cost of capital for the Mills Company that will finance its optimal capital budget with $120 million of long-term debt (kd = 12.5%) and $180 million in retained earnings (ke = 16.0%). Mills' present capital structure is considered optimal. The company's marginal tax rate is 40%.

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Bridger Benitez · Answer 1

The company's weighted cost of capital is 12.6%

Explanation:

Weighted average cost of capital (wacc) is calculated using the following formula:

wacc = [ kd x (1-tax) x weight of debt] + [ke x weight of equity]

in which: kd is the cost of debt = 12.5%

ke is the cost of equity = 16%

Weight of debt = $120m / ($120m+$180m) = 40%

Weight of equity = $180m / ($120m+$180m) = 60%

--> wacc = [0.125 x (1-0.4) x 0.4] + [0.16 x 0.6]

= 12.6%