Question

A firm has $500 in debt at a cost of 7%, a 34% tax rate, a...

A firm has $500 in debt at a cost of 7%, a 34% tax rate, a total firm value of $1,100, and an unlevered return of 14%. What is the firm’s WACC?

            A)     9.24%

            B)     9.74%

            C)     9.88%

            D)     10.67%

            E)     11.84%

Not sure how to do it, help would be much appreciated.

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Homework Answers

Answer #1

Weighted Average Cost Of Capital (WACC)

WACC= We​∗Re + Wd​∗Rd

Where,
Re = cost of equity
Rd = cost of debt
We = Weight of equity in total capital structure
Wd = Weight of debt in total capital structure

Total firm value = Value of debt + Value of equity

Value of debt = $ 500

value of firm = $ 1100

Therefore,

Value of equity = $ 600

Debt and equity are in ratio of 500 : 600

i .e 5 :6

Weight of debt = 5 / 11

Weight of equity = 6 / 11

Cost of debt = I(1- t) ( t = tax rate)

= 7 ( 1 - .34)

= 4.62 %

Unlevered return / Cost of equity = 14 %

WACC= We​∗Re + Wd​∗Rd

= 7.64 + 2.1

= 9.74 %

Hence correct answer is B. WACC = 9.74 %

Hope it helps!

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