Question

# A company is financed with a combination of 55% equity and 45% debt. The company has...

A company is financed with a combination of 55% equity and 45% debt. The company has a beta of 1.75. The risk free rate is 4% and the market rate of return is 16%. The debt is currently being traded in the market is 8.5%. The company tax free rate is 35%. With all these data, answer the following questions:
1. What is the company’s afteer tax cost of debt
2.what is the company’s cost of equity
3. What is the weighted average cost of capital

1A) After tax Cost of debt is weight of debt* cost of debt (1-Tax rate)

= 45%*8.5%(1-35%)

=3.825 (65%)

=2.48 percent

After tax cost of debt is 3.03%

2A) Total Cost of equity = Weight of equity* Cost of equity

Cost of equity as per CAPM

RF+Beta (RM-RF)

=4%+1.75 * (16%-4%)

=4% +21%=25%

Total cost of equity is 55% *25%

=13.75%

So cost of equity of the company is 13.75 percent

3) Weighted average cost of capital (WACC) formula is

Weight of debt* Cost of debt+ Weight of equity * Cost of Equity

45% *2.48+ 55% *13.75

=1.116%+7.5625%

=8.68%

So WACC of the company is 8.68 percent

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