High School

Charlotte's Crochet Shoppe has 17,300 shares of common stock outstanding at a price per share of $85 and a rate of return of 12.01 percent. The company also has 380 bonds outstanding, with a par value of $2,000 per bond. The pretax cost of debt is 6.33 percent, and the bonds sell for 100.2 percent of par.

What is the firm's WACC if the tax rate is 25 percent?

Multiple Choice:
a. 10.07%
b. 10.51%
c. 9.03%
d. 9.53%

Answer :

The firm's WACC is approximately 9.03% (option c) when the tax rate is 25%.

How to determine the firm's WACC

Given information:

Number of shares of common stock outstanding = 17,300

Price per share of common stock = $85

Rate of return (cost of equity) = 12.01%

Number of bonds outstanding = 380

Par value per bond = $2,000

Pretax cost of debt = 6.33%

Bonds sell for 100.2% of par value

Tax rate = 25%

First, let's calculate the weight of equity and debt:

Weight of equity = (Number of shares of common stock outstanding × Price per share of common stock) / Total market value of equity

Weight of equity = (17,300 × $85) / [(17,300 × $85) + (380 × $2,000 × 1.002)]

Weight of equity ≈ 0.9996 (rounded to four decimal places)

Weight of debt = (Number of bonds outstanding × Par value per bond × Selling price of bonds) / Total market value of debt

Weight of debt = (380 × $2,000 × 1.002) / [(17,300 × $85) + (380 × $2,000 × 1.002)]

Weight of debt ≈ 0.0004 (rounded to four decimal places)

Next, let's calculate the cost of equity after tax:

Cost of equity after tax = Rate of return (cost of equity) × (1 - Tax rate)

Cost of equity after tax = 12.01% × (1 - 25%)

Cost of equity after tax ≈ 9.0088% (rounded to four decimal places)

Now, we can calculate the WACC:

WACC = (Weight of equity × Cost of equity after tax) + (Weight of debt × Pretax cost of debt × (1 - Tax rate))

WACC = (0.9996 × 9.0088%) + (0.0004 × 6.33% × (1 - 25%))

WACC ≈ 9.0276% (rounded to four decimal places)

Therefore, the firm's WACC is approximately 9.03% (option c) when the tax rate is 25%.

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