The Tyler Oil Companys capital structure is as follows: Debt 65 % Preferred stock 10 Common equity
Question:
The Tyler Oil Company’s capital structure is as follows:
Debt | 65 | % | |
Preferred stock | 10 | ||
Common equity | 25 | ||
The aftertax cost of debt is 11 percent; the cost of preferred stock is 14 percent; and the cost of common equity (in the form of retained earnings) is 17 percent.
a-1. Calculate Tyler Oil Company’s weighted average cost of capital. (Round the final answers to 2 decimal places.)
Weighted Cost | ||
Debt (Kd) | % | |
Preferred stock (Kp) | ||
Common equity (Ke) | ||
Weighted average cost of capital (Ka) | % | |
As an alternative to the capital structure shown above for Tyler Oil Company’s, an outside consultant has suggested the following modifications.
Debt | 35% | |
Preferred stock | 15 | |
Common equity | 50 | |
Under this new and more debt-oriented arrangement, the aftertax cost of debt is 11.8 percent, the cost of preferred stock is 9 percent, and the cost of common equity (in the form of retained earnings) is 12.0 percent.
a-2. Calculate Tyler’s weighted average cost of capital. (Round the final answers to 2 decimal places.)
Weighted Cost | ||
Debt (Kd) | % | |
Preferred stock (Kp) | ||
Common equity (Ke) | ||
Weighted average cost of capital (Ka) | % | |
b. Which plan is optimal in terms of minimizing the weighted average cost of capital?
Plan 2
Plan 1
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta