Question

Sara's Cafe has the following capital structure:

Bonds   $450 million

Preferred Stock $300 million

Common stock $500 million

Retained Earnings $250 million

The specific costs of capital are as followsl:

Bonds 6.2%

Preferred Stock 7.4%

Common Stock 16.8%

Retained Earnings 14.9%

Calculate the WACC.

Answer 1

Ans :

Note 1 : Calculation of Proportion of Sources of Funds

Sources of Funds	Capital Structures (in millions)	Proportion ( Capital Structure / Valu of the Firm)
Bonds	$450	0.30 (450/1500)
Preferred Stock	$300	0.20 (300/1500)
Common Stock	$500	0.33 (500/1500)
Retained Earnings	$250	0.167(250/1500)
Total Value of the Firm	$1500	1

Computation of Weighted Average Cost of Capital (WACC)

Sources of Funds	Cost of Capital	Proportion	Weighted Cost (Cost of Capital * Proportion)
Bonds	6.2%	0.30	1.86%
Preferred Stock	7.4%	0.20	1.48%
Common Stock	16.8%	0.33	5.6%
Retained Earnings	14.9%	0.167	2.483%
WACC	11.423%

OR

Sources of Funds	Capital Structures (in millions)	Cost of Capital %	Cost of Capital (in $ millions)
Bonds	$450	6.2%	$27.9
Preferred Stock	$300	7.4%	$22.2
Common Stock	$500	16.8%	$84
Retained Earnings	$250	14.9%	$37.25
Total	$1500		$171.35

WACC = Total Cost of Capital / Value of the Firm
= $171.35 / $1500