Question

Cost of Capital Bob's is a retail chain of specialty hardware stores. The firm has 15,000 shares of stock outstanding that are currently valued at $56 a share and provide a 14.4 percent rate of return. The firm also has 1,100 bonds outstanding that have a face value of $1,000, a market price of $1,044, and a 8.5 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 22 percent. What is the firm's WACC?

Answer 1

The firm's Weighted Average Cost of Capital (WACC) is approximately 9.70%.

Step-by-step explanation:

To calculate the firm's WACC, we need to determine the market value of equity, the market value of debt, the cost of equity, and the cost of debt.

1. Market Value of Equity: The market value of equity is calculated by multiplying the number of shares outstanding by the current stock price. In this case, the market value of equity is $56 * 15,000 = $840,000.
2. Market Value of Debt: The market value of debt is the current market price of the bonds multiplied by the number of bonds outstanding. In this case, the market value of debt is $1,044 * 1,100 = $1,148,400.
3. Cost of Equity: The cost of equity is the rate of return expected by the shareholders. In this case, the cost of equity is 14.4%.
4. Cost of Debt: The cost of debt is the interest rate paid by the company on its debt. In this case, the cost of debt is 8.5%.
5. Tax Rate: The tax rate is given as 22%.

Now, we can calculate the WACC using the formula:

WACC = (E/V) * Re + (D/V) * Rd * (1 - Tax Rate)

Substituting the values:

WACC = (840,000 / (840,000 + 1,148,400)) * 0.144 + (1,148,400 / (840,000 + 1,148,400)) * 0.085 * (1 - 0.22)

Simplifying the equation:

WACC = 0.423 * 0.144 + 0.577 * 0.085 * 0.78

Calculating the values:

WACC = 0.060912 + 0.036057

WACC = 0.096969 or 9.70%