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Sound Systems has 200 shares of common stock outstanding at a market price of $37 a share. The firm recently paid an annual dividend in the amount of $1.20 per share and has a dividend growth rate of 4 percent. The firm also has 5 bonds outstanding with a face value of $1,000 per bond that are selling at 99 percent of par. The bonds have a coupon rate of 6 percent and a yield to maturity of 6.7 percent. All interest is tax deductible. If the tax rate is 21 percent, what is the weighted average cost of capital

Sagot :

Answer:

Weighted average cost of capital is 6.46%.

Explanation:

This can be calculated as follows:

Equity value = Number of shares of common stock outstanding * Market price per share = 200 * $37 = $7,400

Debt value = Number of bonds outstanding * Bond face value * Percentage of par at which the bond is selling = 5 * $1,000 * 99% = $4,950

Total value of the firm = Equity value + Debt value = $7,400 + 4,950 = $12,350

Weight of equity = Equity value / Total value of the firm = $7,400 / $12,350 = 0.60, or 60%

Weight of debt = Debt value / Total value of the firm = $4,950 / $12,350 = 0.40, or 60%

Cost of equity = (Annual dividend recently paid / Market price share) + Dividend growth rate = ($1.20 / $37) + 0.04 = 0.0724, or 7.24%

After tax cost of debt = Yield to maturity * (100% - Tax rate) = 6.7% * (100% - 21%) = 5.29%, or 0.0529

Therefore, we have:

Weighted average cost of capital = (Cost of equity * Weight of equity) + (After tax cost of debt * Weight of debt) = (0.0724 * 0.60) + (0.0529 * 0.40) = 0.0646, or 6.46%

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