Question

Miller Manufacturing has a target debt-equity ratio of .30. Its cost of equity is 11.8 percent and its cost of debt is 6.5 percent. If the tax rate is 23 percent, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

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 equity ; W_e = Weight of equity ;

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

As per the information available in the question we have

K_e = 11.8 % ; K_d = 6.5 % ; t = 23 % = 0.23   ;

Debt - equity ratio = 0.30 : 1

Thus weight of debt = 0.30 / ( 1 + 0.30 ) = 0.30 / 1.30 = 0.2308

weight of equity = 1 / ( 1 + 0.30 ) = 1 / 1.30 = 0.7692

Therefore

W_e = 0.7692   ; W_d = 0.2308

Applying the above values in the formula we have

= [ 11.8 * 0.7692 ] + [ ( 6.5 * ( 1 – 0.23 ) ) * 0.2308 ]

= [ 11.8 * 0.6452 ] + [ ( 6.5 * 0.77 * 0.3548 ]

= [ 9.0769 + 1.1550   ]

= 10.2319 %

= 10.23 % ( when rounded off to two decimal place )

Thus the WACC of the company is = 10.23 %