Question

SIROM Scientific Solutions has

$10

million of outstanding equity and

$10

million of bank debt. The bank debt costs

7%

per year. The estimated equity beta is 2. If the market risk premium is

9​%

and the​ risk-free rate is

3​%,

compute the weighted average cost of capital if the​ firm's tax rate is

35​%.

Answer 1

As per CAPM,

R_f = Risk free Return = 3%                                                    

R_mp = Market Risk Premmium= 9%

Beta = 2

Required Rate of Return = 3%+2(9%)

= 21%

Calculating WACC:-

WACC= (Weight of Debt)(Cost of Debt)(1-Tax Rate) + (Weight of Equity)(Cost of Equity)

= [10M/(10M+10M)]*(7%)(1-0.35) + [10M/(10M+10M)]*(21%)

= 2.275% + 10.5%

= 12.775%

So, the weighted average cost of capital is 12.775%

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