Question

Western Electric has 27,500 shares of common stock outstanding at a price per share of $70 and a rate of return of 13.45 percent. The firm has 6,850 shares of 6.90 percent preferred stock outstanding at a price of $90.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $377,000 and currently sells for 106.5 percent of face. The yield to maturity on the debt is 7.81 percent. What is the firm's weighted average cost of capital if the tax rate is 35 percent?

10.50%

10.27%

10.70%

11.46%

11.08%

Answer 1

WACC = Cost of Debt * (1 - Tax Rate) * Weight of debt + Weight of common equity * Cost of common equity + Weight of preferred equity * Cost of preferred equity

All the weights are calculated based on market values.

Market value of debt = 106.5% * $377,000 = $401,505

Market Value of Common Equity = 27,500 * $70 = $1,925,000

Market Value of Preferred Equity = 6,850 * $90.5 = $619,925

Value of total capital = $401,505 + $1,925,000 + $619,925 = $2,946,430

Weight of debt = 401,505/2,946,420 = 13.63%

Weight of common equity = 1,925,000/2,946,420 = 65.33%

Weight of preferred equity = 619,925/2,946,420 = 21.04%

Cost of referred stock = Annual dividend/Market price of share = (6.90% * 100)/90.50 = 7.62%

WACC = [7.81% * (1 - 35%) * 13.63%] + [65.33% * 13.45%] + [21.04% * 7.62%] = 0.69% + 8.79% + 1.60% = 11.08% --> Answer