Question

ABC company’s cost of equity is 12.5%. The company has a target debt-equity ratio of 50%. It cost of debt is 7.5 percent, before taxes. If the tax rate is 21 percent, what is the weighted average cost of capital?

A. 10.00 percent B. 10.31 percent C. 10.83 percent D. 10.97 percent E. None of the above.

Answer 1

Ans:- WACC is given by Cost of equity * % of equity + Cost of debt * % of debt * (1 - Tax rate)

Since debt-equity ratio = 0.50 = 0.50 / 1, that means % of debt will be 0.50 / (1+0.50) = 0.5 / 1.5 and % of equity will be 1 / (1+0.5) =1/1.5

= 12.5% * 1/1.5 + 7.5 * 0.5 / 1.5 * (1 - 0.21) =0.1031 = 10.31%.

Therefore, the weighted average cost of capital of the firm will be 10.31%.option (b) is the right answer.

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