Question

**Problem 9-8**

WACC

David Ortiz Motors has a target capital structure of 30% debt and 70% 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 9.32%. What is the company's cost of equity capital? Round your answer to two decimal places.

%?

Answer #1

Calculation of Cost of equity:

Particulars | Probability (1) | Cost (2) | WACC (3) (1*2) |

Debt | 0.3 | 4.8% (Note) | 1.44% |

Equity | 0.7 | ×% | 0.7*×% |

WACC | 9.32% |

Let cost of equity will be ×%

Calculation of cost of common equity:

0.3*4.8%+0.7*×%= 9.32%

1.44%+0.7*×% = 9.32%

0.7*×% = 9.32%-1.44%

0.7*×%= 7.88%

×% = 7.88%/0.7

×% = 11.26%

Cost of common equity (ke) = 11.26%

Note:Calculation of Cost of debt (kd):

After tax cost of debt = Cost of debt - Tax

= 8%-8%*40%

= 8%-3.2%

kd= 4.8%

Company's Cost of common equity (ke) = 11.26%

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%

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