Question

Charlotte's Crochet Shoppe has 17,000 shares of common stock outstanding at a price per share of $84 and a rate of return of 11.97 percent. The company also has 370 bonds outstanding, with a par value of $2,000 per bond. The pretax cost of debt is 6.31 percent and the bonds sell for 99.9 percent of par. What is the firm's WACC if the tax rate is 35 percent?

Answer 1

Market Value of Debt and Equity

Market Value of Debt = $739,260 [370 Bonds x ($2,000 x 99.90%)]

Market Value of Equity = $14,28,000 [17,000 Common shares x $84.00]

Total Market Value = $21,67,260 [$739,260 + $14,28,000]

Weight of Capital Structure

Weight of Debt = 0.3411 [$739,260 / $21,67,260]

Weight of Equity = 0.6589 [$14,28,000 / $21,67,260]

After-tax Cost of Debt

After Tax Cost of Debt = Pre-tax Cost of Debt x (1 – Tax Rate)

= 6.31% x (1 – 0.35)

= 6.31% x 0.65

= 4.10%

Cost of Common Equity = 11.97% (Given)

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [4.10% x 0.3411] + [11.97% x 0.6589]

= 1.40% + 7.89%

= 9.29%

“Therefore, the Company’s Weighted Average Cost of Capital (WACC) will be 9.29%”