Question

A firm’s capital structure is 10% debt and 90% common equity. The tax rate is 25%, the interest rate on new debt is 12%, and the cost of common equity is 16.15%. The firm’s weighted average cost of capital (WACC) is what %. This is calculated to two decimal places using the following formula: WACC = WCS × CCS + WPS × CPS + WD × CD

Answer #1

WACC = WCS × CCS + WPS × CPS + WD × CD

or WACC =Cost of Equity * Weight of Equity in Capital Structure + Cost of Debt(1-t) * Weight of Debt in Capital Structure + Cost of Preferred Stock * Weight of Preferred Stock in Capital Structure

W_{CS} = Weight of Equity in Capital Structure = 90%
& C_{CS} = Cost of Equity = 16.15%

W_{D} = Weight of Debt in Capital Structure = 10% &
C_{D} = Cost of Debt = 12%

WACC = 16.15% * 90% + 12% * 10% (There is no preference share component in Capital Structure, i.e. WPS =0)

But the Cost of Debt (C_{D)} need to be adjusted for tax
as Interest on borrowings is tax deductible.

WACC = 16.15% * 90% + 12% (1 - 25%) * 10%

**WACC = 14.535% + 0.9% = 15.435% = 15.44%**

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