Question

1. Peter's Audio Shop has a before-tax cost of debt of 7%, a cost of equity of 11%, and a cost of preferred stock of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What is the weighted average cost of capital for Peter's Audio Shop?

Answer 1

Answer:

9.14%

Explanation:

The computation of the weighted average cost of capital is shown below:-

Debt = $500,000 × 1.02

= $0.51 m

Preferred = 40,000 × $34

= $1.36 m

Common = 104,000 × $20

= $2.08 m

Total = $0.51 m + $1.36 m + $2.08 m

= $3.95 m

So, Weighted average cost of capital = ($2.08 ÷ $3.95 m × 0.11) + ($1.36 m ÷ $3.95 m × 0.08) + (($0.51 m ÷ 3.95 m × 0.07 × (1 - 0.34))

= 0.057924 + 0.027544 + 0.005965

= 0.091433

or 9.14%

Therefore for computing the weighted average cost of capital we simply applied the above equation.