Question

David Ortiz Motors has a target capital structure of 45% debt and 55% equity. The yield to maturity on the company's outstanding bonds is 11%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 10.88%. What is the company's cost of equity capital? Round your answer to two decimal places.

Answer 1

- Target Capital Structure: Debt -45%

Equity- 55%

Before-tax cost of Debt (YTM) = 11%

Company's WACC = 10.88%

Calculating the Cost of Equity using the WACC formula:-

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

10.88% = (0.45)(11%)(1-0.40) + (0.55)(Cost of Equity)

10.88% = 2.97% + 0.55(Cost of Equity)

7.91% = 0.55(Cost of Equity)

Cost of Equity Capital = 7.91%/0.55

Cost of Equity Capital = 14.38%

So, the company's cost of equity capital is 14.38%

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