Question

Western Electric has 34,500 shares of common stock outstanding at a price per share of $84 and a rate of return of 12.75 percent. The firm has 7,550 shares of 8.30 percent preferred stock outstanding at a price of $97.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $419,000 and currently sells for 113.5 percent of face. The yield to maturity on the debt is 8.23 percent. What is the firm's weighted average cost of capital if the tax rate is 35 percent?

Answer 1

Answer:

Cost of common stock (Ke) =  12.75%

Cost of preferred stocks (Kp) = $8.30/$97.50

                                                = 0.0851  = 8.51%

Cost of debt = 8.23%

WACC = Ke(E/V) + Kp(P/V) + Kd(D/V)(1-T)

WACC  = 12.75(2,898,000/4,109,690)  +  8.51(736.125/4,109,690)    +  8.23(475,565/4,109,690)

WACC = 8.99 + 1.52+ 0.95

WACC = 11.46%

Market value of the company:                                    $

Market value of common stocks (34,500 x $84)      2,898,000

Market value of preferred stocks (7,550 x $97.50)  736,125

Market value of debt ( $419,000 x $113.5/$100)        475,565

Market value of the company                                     4,109,690                                                                  

Explanation:

In the case, the cost of common stock and cost of debts are given. There is need to calculate cost of preferred stocks, which is the ratio of dividend to current market price of the preferred stocks. Dividend on preferred stocks is calculated as 8.30% x $100 par value, which is $8.30.

We also need to calculate the market value of the company, which is the aggregate of market value of common stock, market value of preferred stock and market value of debt,

WACC is calculated as the aggregate of cost of each stock and the proportion of the market value of each stock to the market value of the company.