Question

The Two Dollar Store has a cost of equity of 11.2 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 .47, what is the weighted average cost of capital?

Answer 1

The weighted average cost of capital is 7.59%

Step-by-step explanation:

In order to calculate the weighted average cost of capital we multiply the cost of each capital source by its weight. In this scenario we are given the debt to equity ratio is 0.47 which means that 47% of the capital is funded by debt and 53%(1-0.47) by equity. We are already given the cost of equity which is 11.2% and the cost of debit is a little different, we multiply the cost of debt by (1-tax rate) in order to find the true cost of debt because interest payments are made before tax is paid so they reduce the tax that a company pays, whereas dividends are not tax exempt.

So the we multiply both the costs by their weights.

0.112*0.53=0.0593

0.058*(1-0.39)*0.47=0.016

We will add both of them up to find the weighted average cost of capital

0.0593+0.016=0.0759

=7.59%