Question

Your boss, whose background is in financial planning, is concerned about the company’s high weighted average cost of capital (WACC) of 27%. He has asked you to determine what combination of debt-equity financing would lower the company’s WACC to 16%. If the cost of the company’s equity capital is 6% and the cost of debt financing is 28%, what debt-equity mix would you recommend?

The debt-equity mix should be ???%

Answer 1

Cost of Equity capital			6% or			0.06
Cost of Debt financing			28% or			0.28
Required Weighted Average cost of capital					16% or	0.16
Weighted average cost of capital = (% of Equity * cost of equity) + (% of Debt * cost of debt)
Assume, Equity = x, So, Debt = 1-x (as overall weight shall be equal to 1)
WACC = (x * 0.06) + { (1-x) * 0.28)
0.16 = 0.06x + 0.28 -0.28x
0.28x - 0.06x = 0.28 -0.16
0.22x = 0.12
x =	0.545455
So, Weight of Equity =			0.545455	or 54.55%
Weight of debt = 1-0.545455 =			0.454545	or 45.45%
So, Debt-equity mix should be 45.45/54.55.