Question

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

Answer #1

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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