Question

Wentworth's Five and Dime Store has a cost of equity of 11.4 percent. The company has an aftertax cost of debt of 5 percent, and the tax rate is 35 percent. If the company's debt–equity ratio is .74, what is the weighted average cost of capital?

Answer 1

Wentworth's Five and Dime Store has a weighted average cost of capital (WACC) of approximately 8.68 percent, calculated using the aftertax cost of debt, cost of equity, and the debt-equity ratio provided.

Step-by-step explanation:

The weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. To calculate the WACC, we need to use the cost of debt, the cost of equity, and the firm's debt-equity ratio. Wentworth's Five and Dime Store has an aftertax cost of debt of 5 percent, a cost of equity of 11.4 percent, and a tax rate of 35 percent with a debt-equity ratio of 0.74. Using this information, we can calculate the WACC with the following formula:

WACC Calculation

1. Calculate the equity proportion: E = 1 / (1 + D/E), where E is the equity proportion and D/E is the debt-to-equity ratio. With D/E = 0.74, the equity proportion (E) is 1 / (1 + 0.74) = 0.575.
2. Calculate the debt proportion: D = 1 - E. With E = 0.575, the debt proportion (D) is 1 - 0.575 = 0.425.
3. Multiply the cost of equity by the equity proportion: Equity Cost = Equity Proportion * Cost of Equity. So, Equity Cost = 0.575 * 11.4% = 6.555%
4. Multiply the aftertax cost of debt by the debt proportion: Debt Cost = Debt Proportion * Aftertax Cost of Debt. So, Debt Cost = 0.425 * 5% = 2.125%
5. Add the weighted costs: WACC = Equity Cost + Debt Cost. Thus, WACC = 6.555% + 2.125% = 8.68%

Therefore, the weighted average cost of capital for Wentworth's Five and Dime Store is approximately 8.68 percent.