Question

The two dollar store has a cost of equity of 10.7 percent, the ytm on the company's bonds is 5.3 percent, and the tax rate is 21 percent. if the company's debt-equity ratio is .42, what is the weighted average cost of capital?

Answer 1

First, we need to calculate the cost of debt:

Cost of debt = YTM on bonds * (1 - Tax rate)

Cost of debt = 5.3% * (1 - 0.21)

Cost of debt = 4.187%

Next, we can calculate the cost of equity using the capital asset pricing model (CAPM):

Cost of equity = Risk-free rate + Beta * (Market risk premium)

Assume the risk-free rate is 2.5%, the beta is 1.2, and the market risk premium is 7% (historical average).

Cost of equity = 2.5% + 1.2 * 7%

Cost of equity = 10.9%

Now, we can use the debt-equity ratio and the cost of debt and equity to calculate the weighted average cost of capital (WACC):

WACC = (Equity / Total capital) * Cost of equity + (Debt / Total capital) * Cost of debt * (1 - Tax rate)

Assume the total capital is $100, with $42 of debt and $58 of equity.

WACC = (58/100) * 10.9% + (42/100) * 4.187% * (1 - 0.21)

WACC = 6.305% + 2.274%

WACC = 8.579%

Therefore, the weighted average cost of capital for the Two Dollar Store is 8.579%.