Sam's Souvenir Shop has a cost of debt of 8 percent, a cost of equity of 12 percent, and a cost of preferred stock of 9 percent. 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 percent. What is the weighted average cost of capital for Sam's Souvenir
Shop?

Question

Quizplus · Accepted Answer

Step 1: Calculate the weight of each capital component

Weight of Debt = (Market Value of Debt) / (Total Market Value of the Firm)
= (900,000 x 1.05) / [(116,000 x 24) + (51,000 x 38) + (900,000 x 1.05)]
= 0.116 or 11.6%

Weight of Preferred Stock = (Market Value of Preferred Stock) / (Total Market Value of the Firm)
= (51,000 x 38) / [(116,000 x 24) + (51,000 x 38) + (900,000 x 1.05)]
= 0.158 or 15.8%

Weight of Common Stock = (Market Value of Common Stock) / (Total Market Value of the Firm)
= (116,000 x 24) / [(116,000 x 24) + (51,000 x 38) + (900,000 x 1.05)]
= 0.726 or 72.6%

Step 2: Calculate the cost of each capital component

Cost of Debt = 8%

Cost of Preferred Stock = 9%

Cost of Common Stock = 12%

Step 3: Calculate the weighted average cost of capital (WACC)

WACC = (Weight of Debt x Cost of Debt) + (Weight of Preferred Stock x Cost of Preferred Stock) + (Weight of Common Stock x Cost of Common Stock)
= (0.116 x 8%) + (0.158 x 9%) + (0.726 x 12%)
= 0.0984 or 9.84%

Therefore, the weighted average cost of capital for Sam's Souvenir Shop is 9.84 percent.

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