Suppose Microsoft has no debt and a WACC of 9.4 %. The average debt-to-value ratio for the software industry is 5.5 %. What would be its cost of equity if it took on the average amount of debt for its industry at a cost of debt of 5.8 %?
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Debt to value ratio for software industry |
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| Debt to value ratio = Debt/Total value = 5.5% or 0.055 | 5.50% | |
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So, equit weight = 1 -0.055= |
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| 0.945 | ||
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Weight average cost of capital = |
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| Cost of debt for industry = | 9.40% | |
| 5.80% | ||
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Weighted average cost of capital = (weight of Equity * Cost of equity)+(Weight of Debt * Cost of equity) |
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9.4 = (0.945 * cost of equity)+(0.055 * 5.8) |
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9.4 - 0.319 = (0.945 * cost of equity) |
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| Cost of equity = | 9.081/0.0945 | |
| cost of equity = | 9.60952381 | |
| or 9.61% | ||
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So, cost of equity is 9.61% |
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