Parasols Ltd has compiled the following information on its financing costs:
|
Type of financing |
Book Value ($million) |
Market Value ($million) |
Before-tax cost % |
|
Long-term debt |
10 |
7.5 |
9 |
|
Secured debt |
5 |
5.0 |
7 |
|
Paid- up capital |
15 |
17.5 |
15 |
|
30 |
30 |
Parasols is in a 30 per cent tax bracket and has a target debt/equity ratio of 100 per cent. It wants to keep its short-term debt at about half of its long-term debt (in market value terms).
a. Calculate the weighted average cost of capital for Parasols using (i) book value weights, (ii) market value weights and (iii) target weights.
b. Explain the difference in the results obtained in part (a). What are the correct weights to use in the weighted average cost of capital?
