Question

A company has a beta of 0.9, pre-tax cost of debt of 5.2% and an effective corporate tax rate of 30%. 24% of its capital structure is debt and the rest is equity. The current risk-free rate is 1.0% and the expected market return is 6.9%. What is this company's weighted average cost of capital? Answ

Answer 1

Ans:

According to Capital asset pricing model,

E(r) = Rf + Beta*(M(r) –Rf)

Ke = Expected rate of return = Cost of Equity

Rf = Risk free return = 1 %

Beta = 0.9

M(r) = Market return = 6.9%

Insert above data in the formula, E(r) = Rf + Beta*(M(r) –Rf)

Ke = 1% + 0.9 (6.9% - 1%)

= 1% + 0.9 * (5.9%)

= 1% + 5.31%

= 6.31%

tax rate = 30%

kd = pre tax rate = 5.2%

W(e) = Weight of Equity = (100%-24%) = 76%

W(d) = Weight of debt = 24%

WACC = W(e) *Ke +W(d) *kd *(1-tax rate)

= 76% * 6.31% + 24% * 5.2% * (1-30%)

= 0.76 *0.0631 +0.24*0.052 *0.7

= 0.047956 + 0.008736

= 0.056692

= 5.6692 %