Sam's Souvenir Shop has a cost of debt of 8 %, a cost of equity of 12 %, and a cost of preferred stock of 9 %. The firm has 116,000 shares of common stock outstanding at a market price of $24 a share. There are 51,000 shares of preferred stock outstanding at a market price of $38 a share. The bond issue has a face value of $900,000 and a market quote of 105. The company's tax rate is 35 %. What is the weighted average cost of capital for Sam's Souvenir Shop?

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Quizplus · Accepted Answer

To calculate the weighted average cost of capital (WACC), we need to find the weights of debt, preferred stock, and equity in the capital structure and then apply the respective costs to these weights.1. Market value of equity (E) = Number of shares * Price per share = 116,000 * $24 = $2,784,0002. Market value of preferred stock (P) = Number of shares * Price per share = 51,000 * $38 = $1,938,0003. Market value of debt (D) = Bond issue face value * Market quote / 100 = $900,000 * 105 / 100 = $945,000Total value of the firm (V) = E + P + D = $2,784,000 + $1,938,000 + $945,000 = $5,667,000Weights:- Weight of equity (W_e) = E / V = $2,784,000 / $5,667,000 = 0.491- Weight of preferred stock (W_p) = P / V = $1,938,000 / $5,667,000 = 0.342- Weight of debt (W_d) = D / V = $945,000 / $5,667,000 = 0.167Costs:- Cost of equity (R_e) = 12%- Cost of preferred stock (R_p) = 9%- Cost of debt (R_d) = 8%- After-tax cost of debt = R_d * (1 - Tax rate) = 8% * (1 - 0.35) = 5.2%WACC = (W_e * R_e) + (W_p * R_p) + (W_d * After-tax R_d)WACC = (0.491 * 12%) + (0.342 * 9%) + (0.167 * 5.2%) = 5.892% + 3.078% + 0.8684% = 9.8384%Rounded to two decimal places, the WACC is approximately 9.84%.

Sam's Souvenir Shop Has a Cost of Debt of 8