Final answer:
The student's question is about calculating the WACC for Charlotte's Crochet Shoppe. The calculation involves determining the market values of equity and debt, and combining the cost of equity and after-tax cost of debt in their respective proportions. The provided rate of return and tax rate are used to compute the components needed for the WACC formula.
Step-by-step explanation:
The student is asking to calculate the weighted average cost of capital (WACC) for Charlotte's Crochet Shoppe, which involves combining the cost of equity and the after-tax cost of debt according to their proportions in the company's capital structure.
To calculate the cost of equity, we use the given rate of return which is 11.89%. For the cost of debt, we take into account that bonds sell for 99.3% of their par value; therefore, each bond sells for $1,986.00 ($2,000 x 99.3%). The pre tax cost of debt is 6.27%, which needs to be adjusted for the 21% tax rate, leading to an after-tax cost of debt of 6.27% x (1 - 0.21) = 4.9533%.
We then calculate the market value of equity (16,400 shares x $82/share = $1,344,800) and the market value of debt (350 bonds x $1,986/bond = $695,100). Using these market values, we can find the proportion of equity (E/V) and the proportion of debt (D/V), where E is the market value of equity, D is the market value of debt, and V is the total market value of the firm's financing (E + D).
To compute WACC, we multiply the cost of equity by the proportion of equity and the after-tax cost of debt by the proportion of debt, and then add them together. The formula for WACC is WACC = (E/V) x Re + (D/V) x Rd x (1 - Tc), where Re is the cost of equity, Rd is the cost of debt, and Tc is the tax rate.