Question

A us based company has a market value of its debt equal to $40 million and has 3 million outstanding shares of stock , each selling for $20 per share. The company pays a 5% rate of interest on its debt and has a beta of 1.41. The corporate tax rate is 34%. The risk premium on the market is 9.5%. the current treasury bill rate is 1%. What is the firm’s weighted average cost of capital?

Answer #1

Ans : **Weighted
Average Cost of Capital**

WACC = (Cost of Equity * Equity Proportion) + (Cost of Debt after
tax * Debt Proportion)

1) **Debt/Equity
Proportion**

Total Capital = Total Debt + Total Equity

= $40 million + (3 million shares * $20 per share)

= $40 million + $60 million

**= $100 milion
Debt Proportion** = Debt / Total Capital = $40 million /
$100 million =

Equity Proportion

2) Cost of Equity/Debt

Cost of Debt after tax

= 5% * (1-34%)

**Cost of Equity =** Risk Free Rate + (Beta *
Market Risk Premium)

= 1% + ( 1.41 * 9.5%)

= 1% + 13.395%

**= 14.395%**

**WACC =** (Cost of Equity * Equity Proportion) +
(Cost of Debt after tax * Debt Proportion)

= (14.395% * 0.6) + (3.3% * 0.4)

= 8.637% + 1.32%

**= 9.957%
Ans : The firm's weighted average cost of capital is
9.957%**

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