Question

12,Western Electric has 29,500 shares of common stock outstanding at a price per share of $74 and a rate of return of 13.25 percent. The firm has 7,050 shares of 7.30 percent preferred stock outstanding at a price of $92.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $389,000 and currently sells for 108.5 percent of face. The yield to maturity on the debt is 7.93 percent. What is the firm's weighted average cost of capital if the tax rate is 39 percent?

Answer 1

Debt:

Face Value of Debt = $389,000

Market Value of Debt = 108.50% * $389,000
Market Value of Debt = $422,065

Annual YTM = 7.93%

Before-tax Cost of Debt = 7.93%
After-tax Cost of Debt = 7.93% * (1 - 0.39)
After-tax Cost of Debt = 4.837%

Preferred Stock:

Number of shares outstanding = 7,050
Current Price = $92.50

Annual Dividend = 7.30%
Annual Dividend = 7.30% * $100
Annual Dividend = $7.30

Market Value of Preferred Stock = 7,050 * $92.50
Market Value of Preferred Stock = $652,125

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $7.30 / $92.50
Cost of Preferred Stock = 7.892%

Equity:

Number of shares outstanding = 29,500
Current Price = $74.00

Market Value of Common Stock = 29,500 * $74.00
Market Value of Common Stock = $2,183,000

Cost of Common Equity = 13.250%

Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock
Market Value of Firm = $422,065 + $652,125 + $2,183,000
Market Value of Firm = $3,257,190

Weight of Debt = $422,065 / $3,257,190
Weight of Debt = 0.1296

Weight of Preferred Stock = $652,125 / $3,257,190
Weight of Preferred Stock = 0.2002

Weight of Common Stock = $2,183,000 / $3,257,190
Weight of Common Stock = 0.6702

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.1296 * 4.837% + 0.2002 * 7.892% + 0.6702 * 13.250%
WACC = 11.08%