Weighted Average Cost of Capital Calculation for Pete's Garden House
What is the firm's weighted average cost of capital for Pete's Garden House?
A) 12.19 percent
B) 12.27 percent
C) 12.77 percent
D) 12.96 percent
Final answer:
The weighted average cost of capital (WACC) for Pete's Garden House, given the provided information including cost of equity, after-tax cost of debt, debt-equity ratio, and tax rate, can be calculated using the WACC formula.
Given the information provided, we can use the formula for calculating the firm's weighted average cost of capital (WACC). The formula for WACC is as follows: WACC = Re * (E / V) + Rd * (1 – Tc) * (D / V), where Re is cost of equity, Rd is the after-tax cost of debt, E is equity, D is debt, V is the total market value of the firm's equity and debt, and Tc is the corporate tax rate.
In Pete’s Garden House case, the equity-to-value ratio is 1 / (1 + debt-equity ratio) = 1 / 1.45 ≈ 0.69 while the debt-to-value ratio is 1 - equity-to-value ratio = 0.31. The WACC would then be (15.6% * 0.69) + (7.1% * (1 - 35%) * 0.31), which equals about 12.19 percent. Therefore, option A) is correct.
Weighted Average Cost of Capital (WACC) is an important financial metric that represents the average rate of return a company is expected to pay to all its security holders to finance its assets.
It takes into consideration the cost of equity and debt, as well as the proportion of each in the company's capital structure.Knowing the WACC helps the company in making investment decisions, as it provides an insight into the minimum return that the company should make on its investments to satisfy all its stakeholders.