Question

Western Electric has 25,500 shares of common stock outstanding at a price per share of $66 and a rate of return of 13.65 percent. The firm has 6,650 shares of 6.50 percent preferred stock outstanding at a price of $88.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $365,000 and currently sells for 104.5 percent of face. The yield to maturity on the debt is 7.69 percent. What is the firm's weighted average cost of capital if the tax rate is 40 percent?

Multiple Choice

• 10.57%

• 10.95%

• 11.39%

• 10.15%

• 10.38%

Answer 1

Hence, the correct answer is the second option showing 10.95%

Note 1: Cost of preferred stock = Annual dividend / Market price = 6.5% x 100 / 88.50 = 7.34%

Note 2: Post tax cost of equity instruments are same as pre tax cost as dividends are not tax deductible

Note 3: Post tax cost of debt = Pre tax cost of debt x (1 - tax rate of 40%)

Please see the table below. Please be guided by the second row to understand the mathematics. The cell in the last row highlighted in yellow is your answer. All financials are in $.

Component	Number	Price	Market Value	Porportion	Pre tax cost	Post tax cost	Component Cost
	N	P	MV = N X P	w = MVi / MVtotal	A	B	w x B
Common stock	25,000	66	1,650,000	62.98%	13.65%	13.65% (Note 2)	8.60%
Preferred stock	6,650	88.50	588,525	22.46%	7.34% (Note 1)	7.34% (Note 2)	1.65%
Bonds	365	1,045	381,425	14.56%	7.69%	4.61% (Note 3)	0.67%
Total			2,619,950				10.92%

Hence, the correct answer is the second option showing 10.95%