Question

Wentworth's Five and Dime Store has a cost of equity of 11.8 percent. The company has an aftertax cost of debt of 5.3 percent, and the tax rate is 39 percent. If the company's debt–equity ratio is .78, what is the weighted average cost of capital? Multiple Choice 6.99% 8.05% 6.91% 7.53% 8.95%

Answer 1

Option (e) is correct

The formula for weighted average cost of capital is:

WACC = w_e * r_e + w_d* r_d * (1 - t)

where, w_e = Percentage of equity

w_d = Percentage of debt

r_e = Cost of equity = 11.8%

r_d * (1 - t) = After tax cost of debt = 5.3%

First we will calculate the weights of debt and equity as per below:

Debt equity ratio = 0.78

Debt / Equity = 0.78 / 1

Debt = 0.78 / 1.78 = 43.82%

Equity = 1 / 1.78 = 56.18%

Now, putting these values in the WACC formula, we get,

WACC = ((56.18% * 11.8%) + (43.82% * 5.3%))

WACC = 6.63% + 2.32% = 8.95%