Question

Peter's Audio has a yield to maturity on its debt of 7.8 percent, a cost of equity of 12.4 percent, and a cost of preferred stock of 8 percent. The firm has 105,000 shares of common stock outstanding at a market price of $22 a share. There are 25,000 shares of preferred stock outstanding at a market price of $45 a share. The bond issue has a total face value of $1.5 million and sells at 98 percent of face value. If the tax rate is 34 percent, what is the weighted average cost of capital?

Answer 1

Answer:

the weighted average cost of capital is 9.22 %.

Explanation:

Weighted average cost of capital is the weighted return required by all providers of permanent sources of finance to the Company.

WACC = ke × (e/v) + kp × (p/v) + kd × (d/v)

where,

ke = cost of equity

    = 12.40 %

e/v = weight of equity

     = ($22 × 105,000) ÷ ($22 × 105,000 + $45 × 25,000 + $1,500,000 × 98%)

     = 0.4709

kp = cost of preference stock

    = 8.00 %

p /v = weight of preference stock

      = ($45 × 25,000) ÷ ($22 × 105,000 + $45 × 25,000 + $1,500,000 × 98%)

      = 0.2294

kd = cost of debt

    = Interest × ( 1 - tax rate)

    = 7.80 % × (1 - 0.34)

    = 5.148%

d/v = weight of debt

     = ($1,500,000 × 98%) ÷ ($22 × 105,000 + $45 × 25,000 + $1,500,000 × 98%)

     = 0.2997

Therefore,

WACC = 12.40 % × 0.4709 + 8.00 % × 0.2294 + 5.148% × 0.2997

           = 9.22 %