Question

Sixx AM Manufacturing has a target debt—equity ratio of 1.9. Its cost of equity is 0.09, and its pretax cost of debt is 0.04. If the tax rate is 0.31, what is the company's WACC? Enter the answer with 4 decimals (e.g. 0.0123)

Answer 1

First we will calculate the weights of debt and equity as below:

Debt equity ratio = debt / equity

1.9 = Debt / Equity

Debt = 1.9 * Equity

The formula for weighted average cost of capital is:

WACC = we * re + wd* rd * (1 - t)

where, we = Weight of equity = 1

wd = Weight of debt = 1.9

re = Cost of equity = 0.09

t = tax rate = 0.31

rd = Cost of debt = 0.04

Now, putting these values in the WACC formula, we get,

WACC = ((1 * 0.09) + (1.9 * 0.04) * (1- 0.31))

WACC = 0.09 + (0.076 * 0.69)

WACC = 0.09 + 0.05244 = 0.1424