Question

The Two Dollar Store has a cost of equity of 12.3 percent, the YTM on the company's bonds is 5.8 percent, and the tax rate is 39 percent. If the company's debt–equity ratio is .58, what is the weighted average cost of capital?

8.62%

9.08%

6.75%

7.90%

9.69%

Upton Umbrellas has a cost of equity of 12.2 percent, the YTM on the company's bonds is 6.1 percent, and the tax rate is 40 percent. The company's bonds sell for 103.8 percent of par. The debt has a book value of $426,000 and total assets have a book value of $958,000. If the market-to-book ratio is 2.92 times, what is the company's WACC?

10.31%

5.55%

10.04%

8.32%

8.46%

Answer 1

Question - 1

When debt = 0.58 and equity = 1 then total assets = 1.58

Weight of Debt = Wd = 0.58/1.58

Weight of Equity = We = 1/1.58

WACC = Ke * (We) + Kd (Wd) ( 1 - tax rate)

= 12.3 * (1 / 1.58) + 5.8 * (0.58/1.58) * ( 1 - 0.39) = 9.08 % .......... Option - B

Question - 2

Market value of debt = 103.80 % of 426000 = 442188

Market value of Equity = (958000 - 426000) * 2.92 times = 1553440

Wd = 442188 / (1553440+442188) = 0.221578

We = 1553440 / (1553440+442188) = 0.77842

WACC = 12.20 * 0.77842 + 6.1 * 0.221578 * 0.60 = 10.31 % ............ Option - A

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