Question

A company has a beta of 2.0, pre-tax cost of debt of 5.1% and an effective corporate tax rate of 29%. 31% of its capital structure is debt and the rest is equity. The current risk-free rate is 0.7% and the expected market risk premium is 5.7%. What is this company's weighted average cost of capital? Answer in percent, rounded to two decimal places.

Answer 1

Weighted Average Cost of Capital

WACC =  Ke * % Weights + Kd * % weights

= 1.4%*69%+ 3.62%*31%

= 0.97+ 1.12

= 2.09% (Answer)

Particulars	Percentage Contribution in total Capital(Weights)(in %)	Cost of Capital(in %)	Weighted Average Cost of Capital(in %)
Equity	69	1.4	0.97
Debt	31	3.62	1.12

Working Notes

1) Cost of capital of equity (Ke)

Ke = Rf + B(Rm - Rf)

where,

Ke is the cost of capital of equity, Rf is risk free rate of return, B is beta and (Rm - Rf) is Expected market risk premium

So,

Ke = 0.7+2(5.7) = 1.4%

2) Cost of capital of debt (Kd)

Here we have pre tax cost of debt = 5.1% and tax rate = 29%

After tax cost of debt(Kd) = pre tax debt rate(1- tax rate)

= 5.1(1-.29) = 3.62%