Question

SIROM Scientific Solutions has equity with a market value of $10 million and $5 million of bank debt. The bank debt costs 6% per year. The estimated equity beta is 2. If the market risk premium is 8% and the risk-free rate is 3%, compute the WACC if the firm’s tax rate is 21%.

14.25%

13.83%

12.93%

12.66%

Answer 1

Ans : Weighted Average Cost of Capital is the average cost of capital of the company

Step 1 : Calculation of Cost of Equity and after tax cost of debt

Expected Return = Risk Free Rate + Beta * Risk Premium
= 3% + 2 * 8%
= 3% + 16%
= 19%

Cost of Equity = 19%

Cost of debt after tax = Cost of Debt * (1-Tax Rate)
= 6 * (1 - 21% )
= 4.74%

Step 2 : Calulation of Equity and Debt Proportion

Total Value = 10 million + 5 million = 15 million

Equity Proportion = 10 / 15 = 0.667
Debt Proportion = 5 / 15 = 0.333

Step 3 : Calculation of WACC

WACC = Equity Proportion * Cost of Equity + Debt Proportion * Cost of Debt after Tax
= 0.667 * 19% + 0.333 * 4.74%
= 12.67% + 1.58%
= 14.25%

Ans : WACC = 14.25%