A company has the following amount and specific costs of each type of

QUESTION

A company has the following amount and specific costs of each type of capital:
Types of Capital Book Value ( in $) Market Value Specific Costs
Preference 100000 110000 8%
Equity 600000 1200000 13%
Retained Earnings 200000 “ “
Debt 400000 380000 5%
Total 1300000 1690000

Determine the weighted average cost of capital using
a) Book value weights
b) Market value weights.
How are they different? Can you think of a situation where the WACC would be the same using either of the weights?
Types of capital Book value Market value Specific costs Book value weights Market value weights Preference 100000 110000 8% 7.69% 5.82% Equity 600000 1200000 13% 46.15% 63.49% Retained earnings 200000 200000 13% 15.38% 10.58% Debt 400000 380000 5% 30.77% 20.11% Total 1300000 1890000 100% 100% Weighted average cost of capital (WACC) Based on book value 10.15% [7.69%*8%+46.15%*13%+15.38%*13%+30.77%*5%] Note: Cost of retained earnings is assumed to be same as cost of equity (ignoring floations¦

s) Based on market value 11.10% [5.82%*8%+63.49%*13%+10.58%*13%+20.11%*5%] Note: Cost of retained earnings is assumed to be same as cost of equity (ignoring floations costs) WACCC as per market value is higher. WACC could be same as per book value and market value when the book value and market value of all types of capital are same

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