May 22, 2011
IP-4

Capital | Debt 50% | Equity 50% | Bonds | 4% | C. Stock (20) | 12% | tax | 40% | P. Stock (30) | 6% |
The common stockholders have an expected return of 12%, preferred stockholders have an expected return of 6%, and the firm's bondholders purchased the firms bonds at a yield to maturity (YTM) of 4%. The firm's tax rate is 40%.
Common stock $2,000,000
Preferred stock $3,000,000
Long-term debts (bonds) $5,000,000
Total liabilities + equity = $10,000,000

1. Calculate the firm's WACC

= 50% (4%)(1-40%) + 20%(12%) + 30%(6%)
= .50(.04)(1-.40) + .20(.12) + .30(.06)
= 0.012 + .042
= .054 or 5.4 %

2. If, as the firm's CFO, you wished to lower the WACC, make up a set of new dollar figures using different amounts of common stock, preferred stock, and long-term debt that would lower the WACC. Show the calculations to demonstrate that the new capital structure has a lower WACC than the original structure. Capital | Debt 60% | Equity 40% | Bonds | 4% | C. Stock (10) | 12% | tax | 40% | P. Stock (30) | 6% | Common stock $1,000,000 Preferred stock $3,000,000 Long-term debts (bonds) $6,000,000 Total liabilities + equity = $10,000,000

= 60%(4%)(1-40%) + 10%(12%) + 30%(6%)
= .60(.04)(1-.40) + .10(.12) + .30(.06)
= 0.0144 + .03
= .0444 or 4.44 % 3. Explain why you may want to lower the firm's WACC.
By increasing the firm’s dept and contribution by the preferred stock holders, the WACC has decreased. A CFO may want to lower a firm’s WACC as an expressed desire to improve ROE. This can be done by the approval of more projects that were previously denied because the WACC was too high.
Also, the lower