Question

Question 66: Cannondale can issue bonds with a coupon rate of 6%. It’s target capital structure calls for 45% debt and 55% common equity (assume they do not use preferred stock). Its cost of internal common equity is 12%. Assuming a corporate tax rate of 40%, Calculate the company’s WACC.

A. 10.22%

B. 9.22%

C. 8.22%

D. 7.22%

Answer 1

Solution:

The formula for calculating the weighted average cost of capital is =

WACC = [ K_e * W_e ] + [ ( K_d * ( 1- t ) ) * W_d ]

K_e = Cost of common equity ; W_e = Weight of common equity ;

K_d = Cost of debt    ; t = Income tax rate ; W_d = Weight of debt

As per the information available in the question we have

K_e = 12 % = 0.12   ; W_e = 55 % = 0.55 ;   K_d = 6 % = 0.06 ; t = 40 % = 0.40   ; W_d = 45 % = 0.45

Applying the above values in the formula we have

= [ 0.12 * 0.55 ] + [ (0.06 * ( 1 – 0.40 ) ) * 0.45 ]

= [ 0.0660 ] + [ (0.06 * 0.60 * 0.45 ]

= [ 0.0660 + 0.0162   ]

= 0.0822

= 8.22 %

Thus the WACC of the company is = 8.22 %

The solution is Option C. 8.22 %