Silverstone and Moore has 10,000 shares of common stock outstanding at a price p

Question

Silverstone and Moore has 10,000 shares of common stock outstanding at a price per share of $46 and a rate of return of 14%. The firm has 5,000 shares of preferred stock outstanding at a price of $58 a share and a rate of return of 12.07%. The outstanding debt has a total face value of $200,000 and a market price equal to 98% of face value. The yield-to-maturity on the debt is 8.03%. What is the firm's weighted average cost of capital if the tax rate is 34%? Answer a. 12.65% b. 11.61% c. 9.99% d. 12.12% e. 8.62% Silverstone and Moore has 10,000 shares of common stock outstanding at a price per share of $46 and a rate of return of 14%. The firm has 5,000 shares of preferred stock outstanding at a price of $58 a share and a rate of return of 12.07%. The outstanding debt has a total face value of $200,000 and a market price equal to 98% of face value. The yield-to-maturity on the debt is 8.03%. What is the firm's weighted average cost of capital if the tax rate is 34%? Silverstone and Moore has 10,000 shares of common stock outstanding at a price per share of $46 and a rate of return of 14%. The firm has 5,000 shares of preferred stock outstanding at a price of $58 a share and a rate of return of 12.07%. The outstanding debt has a total face value of $200,000 and a market price equal to 98% of face value. The yield-to-maturity on the debt is 8.03%. What is the firm's weighted average cost of capital if the tax rate is 34%? 12.65% 11.61% 9.99% 12.12% 8.62% a. 12.65% b. 11.61% c. 9.99% d. 12.12% e. 8.62%

Explanation / Answer

The formula to find the weight average cost of capital (WACC) is:

WACC = P / V * Rp + C / V * Rc + D / V * Rd * (1 - T)

Where P = market value of preferred stock, C = market value of common stock, D = market value of debt, V = P + C + D, Rc = cost of common stock (i.e. the rate), Rd = cost of debt (i.e. the rate), Rp = cost of preferred stock (i.e. the rate) and T = tax rate.

For your problem P = 5,000 * $58 = $290,000; C = 10,000 * $46 = $460,000; D = $200,000 * 0.98 = $196,000 V = $290,000 + $460,000 + $196,000 = $946,000; Rp = 12.07%; Rc = 14%, Rd = 8.03%; T = 34%

WACC = $290,000 / $946,000 * 0.1207 + $460,000 / $946,000 * 0.14 + $196,000 / $946,000 * (1 - 0.34)

WACC = 0.30655 * 0.1207 + 0.48626 * 0.14 + 0.20719 * 0.0803 * 0.66

WACC = 0.03700 + 0.06808 + 0.01098 = 0.11606 = 11.606%, so the answer is b.

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