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1 month ago

Feldspar Inc. is considering the capital structure for a new division. Management has been given the following cost information:

Business

1 answer:

Mariulka [3.8K]1 month ago

8 0

Response:

Select option 4

Clarification:

This question involves calculating the WACC as shown below:

= Weight of debt × debt cost × (1 - tax rate) + (Weight of common stock) × (cost of common stock)

For Option 1:

= (0.3 × 10%) × (1 - 40%) + (0.7 × 12.5%)

= 1.8% + 8.75%

= 10.55%

For Option 2:

= (0.4 × 10.5%) × (1 - 40%) + (0.6 × 13%)

= 2.52% + 7.8%

= 10.32%

For Option 3:

= (0.5 × 11%) × (1 - 40%) + (0.5 × 13.5%)

= 3.3% + 6.75%

= 10.05%

For Option 4:

= (0.6 × 11.7%) × (1 - 40%) + (0.4 × 14.2%)

= 4.212% + 5.68%

= 9.89%

For Option 5:

= (0.7 × 13%) × (1 - 40%) + (0.3 × 15.5%)

= 5.46% + 4.65%

= 10.11%

Consequently, management should opt for option 4 as it yields the most favorable debt asset ratio

The equity weight is defined as

= 1 - debt weight

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