Question

Western Electric has 31,000 shares of common stock outstanding at a price per share of $77 and a rate of return of 13.10 percent. The firm has 7,200 shares of 7.60 percent preferred stock outstanding at a price of $94.00 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $398,000 and currently sells for 110 percent of face. The yield to maturity on the debt is 8.02 percent. What is the firm's weighted average cost of capital if the tax rate is 39 percent? Multiple Choice O 10.29% O 11.10% O 10.52% O 10.72% O 11.50%

Answer 1

After Tax Cost of Debt Pre tax cost of debt*(1-tax rate) 0.0802*(1-0.39) 0.048922 4.89% Preference Face value preference dividend Market price Cost of preference shares 100 7.6 Cost of Equity 13.10% (7.6/94) 0.0809 8.09% Debt preference Equity 398000*110% 7200*94 31000*77 Market value $ 437,800.00 $ 676,800.00 $ 2,387,000.00 $ 3,501,600.00 Market value weight cost 0.12503 0.19328 0.68169 WACC WACC product 0.0489 0.0061 0.0809 0.0156 0.1310 0.0893 0.111045 11.10%

Answer 2

SOLUTION  

EQUITY :

Market value of equity = E = No. of shares * MV per share = 31000 * 77 = 2387000 ($)

Return on equity = rE = 13.10 %

PREFERRED STOCK :

Market value of Preferred stock = PS = No. Of shares * MV = 7200 * 94 = 676800 ($)

Return on PS = rP = 7.60 / 94 = 0.08085 = 8.085 % 

DEBT :

Market value of debt = D = FV * price per $ of FV = 398000 * 110/100 = 437800 ($) 

Effective interest on debt = rD =  YTM * (1 - T) = 8.02 * (1 - 0.3)9 = 4.892 % 

TOTAL CAPITA MV BASED :

Total capital as per MV = C = E + PS + D = 2387000 + 676800 + 437800 = 3501600 ($)

WEIGHTS OF CAPITAL COMPONENTS :

Weight of equity = wE = E / C = 2387000 / 3501600 = 0.6817

Weight of PS = wPS = PS / C = 676800 / 3501600 = 0.1933

Weight of debt = wD = D / C = 437800 / 3501600 = 0.1250

WEIGHED AVERAGE CAPITAL COST ;

WACC 

= wE * rE + wPS * rPS + wD * rD 

= 0.6817 * 13.10 + 0.1933 * 8.085 + 0.1250 * 4.892

= 11.10 %  approx. : 2nd Option   (ANSWER).