Detailed Answer
(a) The requirement is to calculate the weighted average
cost of capital. The weighted-average cost of capital is
determined by summing the cost of each funding source
weighted by its percentage of the total. In this case, the funds
received from the debt are equal to 99% (101% – 2%) ×
$15,000,000, or $14,850,000, and the funds from equity is $35
million, the amount of retained earnings. Therefore, total
funding is $49,850,000. The weighted-average cost of capital is
equal to ($14,850,000/$49,850,000) × 7% +
($35,000,000/$49,850,000) × 12% = 10.50%. Thus, the answer
is (a).