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Berkshire Instruments: WACC Calculation and Analysis

Al Hansen, the vice president of finance at Berkshire Instruments, is tasked with determining the firm's cost of capital. He examines the current balance sheet and past costs of debt and preferred stock. However, his investment banker advises him to focus on the current cost of funds instead of historical costs.

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Added on  2023-03-23

About This Document

This document provides a step-by-step guide on calculating the weighted average cost of capital (WACC) for Berkshire Instruments using both the retained earnings and new equity methods. It explains the significance of WACC in determining the cost of financing and making investment decisions. The document also includes a comparison of the two methods and suggests the preferred option based on lower cost.

Berkshire Instruments: WACC Calculation and Analysis

Al Hansen, the vice president of finance at Berkshire Instruments, is tasked with determining the firm's cost of capital. He examines the current balance sheet and past costs of debt and preferred stock. However, his investment banker advises him to focus on the current cost of funds instead of historical costs.

   Added on 2023-03-23

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Running Head: Berkshire Instruments 1
Berkshire Instruments
[Name of Writer]
[Name of Institution]
Berkshire Instruments: WACC Calculation and Analysis_1
Berkshire Instruments 2
Question 1
Part 1
WACC Based on retained earning
Cost components of capital structure
a) Cost of debt: -
Maturity 20
Interest 9.30%
Per value 1000
Market Value 890
Per year interest = 1000*9.3% = 93
Cost of debt after tax = 9.3% * (1-35%)
Cost of debt after tax = 9.3%X (.65)
= 6.045
Weight of Debt = Total debt/ Long term capital
= 6,120,000 / 18,000,000
= 0.34
b) Cost of preferred stock: -
Market price = 60
Annual dividend = 4.8
Floating cost = 2.6
Net price of preferred stock = 60-2.6
= 57.4
Cost of Preferred Stock = 4.8 / 57.4
= 8.36
Berkshire Instruments: WACC Calculation and Analysis_2
Berkshire Instruments 3
Weight of Proffered stock = Total preferred stock / long term capital
= 1,080,000 / 18,000,000
= 6%
C) Cost of Retained Earning: -
Using dividend discount model,
C = (Dividend + Growth rate) / Market price
Dividend = 3 * 40%= 1.2
Market price = 25
G =?
Dividend growth 1.2 in 4 years’ dividend current= 0.82
Using compound interest formula
1.2 = 0.82 (1+g)4
1.2/.82 = (1+g)4
(1.4634)1/4 = (1+g)4x1/4
G = 10%
Now cost of equity = 1.2/25 + 10%
= 14.80%
Weight of Equity = 1,080,000 / 18,000,000
= 6%
So therefore WACC would be
Cost Weight Cost *
Weight
WACC
Debt 6.045% 34% 2.0553 11.4369
P Stock 8.36% 6% 0.5016
C Stock 14.8% 60% 8.88
Berkshire Instruments: WACC Calculation and Analysis_3

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