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

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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