Question

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 8%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 11.40%. What is the company's cost of equity capital? Round your answer to two decimal places.

Answer 1

given WACC = 11.40%

=> (proportion of debt * after tax cost of debt) + (proportion of equity * cost of equity) = 11.40%

here,

proportion of debt = 40%

after tax cost of debt = yield to maturity *(1-tax rate)

=>8%*(1-0.40)

=>4.80%

proportion of equity = 60%

cost of equity = to be found out

now, substituting the above terms in the equation:

(0.40*0.0480) + (0.60 * cost of equity) = 0.1140

=>0.0192 + 0.6 * cost of equity = 0.1140

=>0.60* cost of equity = 0.0948

=>cost of equity = 0.0948 /0.60

=>cost of equity = 0.158

=>15.80%

the company's cost of equity =15.80%.