Question

Western Electric has 34,000 shares of common stock outstanding at a price per share of $83 and a rate of return of 12.80 percent. The firm has 7,500 shares of 8.20 percent preferred stock outstanding at a price of $97.00 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $416,000 and currently sells for 113 percent of face. The yield to maturity on the debt is 8.20 percent. What is the firm's weighted average cost of capital if the tax rate is 40 percent

Answer 1

11.03 %

Step-by-step explanation:

Cost of Capital = Cost of equity x Weight of Equity + Cost of Preferred Stock x Weight of Preferred Stock + Cost of Debt x Weight of Debt.

where,

Cost of equity = 12.80 %

Cost of Preferred Stock = 8.20 %

Cost of Debt = 8.20 x (1 - 0.40) = 4.92 %

also,

Total Market Value = 34,000 x $83 + 7,500 x $97.00 + $416,000 x 113%

= $2,822,000 + $727,500 + $470,080

= $4,019,580

Weight of Equity = $2,822,000 ÷ $4,019,580 = 0.70

Weight of Preferred Stock = $727,500 ÷ $4,019,580 = 0.18

Weight of Debt = $470,080 ÷ $4,019,580 = 0.12

therefore,

Cost of Capital = 12.80 % x 0.70 + 8.20 % x 0.18 + 4.92 % x 0.12

= 11.03 %