Western Electric has 23,000 shares of common stock outstanding at a price per share of $61 and a rate of return of 13.90 percent. The firm has 6,000 shares of 7.00 percent preferred stock outstanding at a price of $86.00 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield to maturity on the debt is 8.49 percent. What is the firm's weighted average cost of capital if the tax rate is 34 percent?

11.04%

Explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that is expected from a project. It shows the risk of the company.

Capital Source       Market Value       Weight      Cost      Total Cost

common stock         $1,403,000         61.64%    13.90%      8.57%

preferred stock           $516,000        22.67%     7.00%       1.59%

debt                            $357,000         15.69%     5.60%       0.88%

Total                         $2,276,000       100.00%                     11.04%

common stock

Market Value = 23,000 shares × $61 = $1,403,000

Cost = 13.90%

preferred stock

Market Value = 6,000 shares × $86.00 = $516,000

Cost = 7.00%

Debt

Market Value = $350,000 × 102% = $357,000

Cost = Interest × ( 1 - tax rate)

        = 8.49 % × ( 1 - 0.34)

        = 5.60%

Therefore, the firm's weighted average cost of capital is 11.04%.

11.04%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

Formula for WACC

Weighted Average Cost of Capital = (Cost of Equity x Weightage of equity) + (Cost of preferred Stock x Weightage of preferred Stock ) + (Cost of Debt (1 -t) x Weightage of Debt)

Weightage

Equity = $61 x 23,000 shares = $1,403,000

Preferred = $86 x 6,000 shares = $516,000

Debt  = $350,000 x 102% = $357,000

Total Value =  $1,403,000 + $516,000 + $357,000 =  $2,276,000

Cost of Equity = 13.90%

Cost of Preferred stock 7%

Cost of Debt = 8.49%

Placing values in the formula

Weighted Average Cost of Capital = ( 13.90% x $1,403,000 / $2,276,000 ) + ( 7% x $516,000 / $2,276,000 ) + ( 8.49% (1 - 0.34) x $357,000 / $2,276,000)

Weighted Average Cost of Capital = 8.57% + 1.59% + 0.88% = 11.04%

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