Question

Peter’s Audio Shop has a cost of debt of 7 percent, a cost of equity of 11 percent. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. The bond issue has a total face value of $500,000 and sells at 102 percent of face value. The company’s tax rate is 34 percent. What is the weighted average cost of capital for Peter’s Audio Shop?

Answer 1

9.14%

Explanation:

The computation of the weighted average cost of capital is shown below:

= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of preferred stock) × (cost of preferred stock) + (Weightage of common stock) × (cost of common stock)

where,

Weighted of debt = Debt ÷ total firm

The total firm includes debt, preferred stock, and the equity which equals to

= $0.51 million + $1.36 million + $2.08 million

= $3.95 million

So, Weighted of debt = ($500,000 × 102% ÷ $3.95 million) = 0.12911392

So, the weight of preferred stock = (Preferred stock ÷ total firm)

= 40,000 shares × $34 ÷ $3.95 million

= 0.344303797

And, the weighted of common stock = (Common stock ÷ total firm)

= 104,000 shares × $20 ÷ $3.95 million

= 0.52658227

Now put these values to the above formula

So, the value would equal to

= (0.07 × $0.129 million) × ( 1 - 34%) + ($0.344 million × 8%) + (0.11 × $0.527 million)

= 0.5965% + 2.75% + 5.792%

= 9.14%