Question

In: Finance

Charlotte's Crochet Shoppe has 14,000 shares of common stock outstanding at a price per share of...

Charlotte's Crochet Shoppe has 14,000 shares of common stock outstanding at a price per share of $74 and a rate of return of 11.57 percent. The company also has 270 bonds outstanding, with a par value of $2,000 per bond. The pretax cost of debt is 6.11 percent and the bonds sell for 96.9 percent of par. What is the firm's WACC if the tax rate is 39 percent?

Expert Solution

Solution:

As per the information given in the question we have

a. No. of shares of common stock outstanding = 14,000 ; Market price per share = $ 74

Market value of the Equity shares or Common stock = No. of shares of common stock outstanding * Market price per share

= 14,000 * $ 74

= $ 1,036,000

Thus the Market value of Common Stock = $ 1,036,000

b.Par value of the bonds = $ 2000 per bond

No. of bonds outstanding = 270

Selling price of the bonds = 96.9 % of par

Thus the market value of the bonds = Par value of the bonds * No. of bonds outstanding * Selling price of the bonds

= 270 * $ 2,000 * 96.9 %

= $ 523,260

c.Thus Weight of equity shares or Common stock = [ 1,036,000 / ( 1,036,000 + 523,260 ) ]

= 1,036,000 / 1,559,260

= 0.664418

d.Thus Weight of bonds = [ 523,260 / ( 1,036,000 + 523,260 ) ]

= 540,000 / 1,559,260

= 0.335582

Rate of return of common stock = Cost of equity = 11.57 % ;

Pre tax Cost of bonds = cost of debt = 6.11 %

Calculation of WACC :

The formula for calculating the weighted average cost of capital is =

WACC = [ K_e * W_e ] + [ ( K_d * ( 1- t ) ) * W_d ]

K_e = Cost of equity ; W_e = Weight of equity ; K_d = Cost of debt ; t = Income tax rate ; W_d = Weight of debt

As per the information available in the question we have

K_e = 11.57 % = 0.1157 ; W_e = 0.664418 ; K_d = 6.11 % = 0.0611 ; t = 39 % = 0.39 ; W_d = 0.335582

Applying the above values in the formula we have

= [ 0.1157 * 0.664418 ] + [ (0.0611 * ( 1 – 0.39 ) ) * 0.335582 ]

= [[ 0.1157 * 0.664418 ] + [ (0.0611 * 0.61* 0.335582 ]

= [ 0.076873 + 0.012507 ]

= 0.089381

= 8.9381 % ( when rounded off to four decimal places)

= 8.94 % ( when rounded off to two decimal places)

Thus the WACC of the firm = 8.94 %

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