Question

WACC

David Ortiz Motors has a target capital structure of 35% debt and 65% equity. The yield to maturity on the company's outstanding bonds is 12%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 11.88%. What is the company's cost of equity capital? Round your answer to two decimal places.

%

Answer 1

Information provided:

Weight of debt in the capital structure= 35%

Weight of equity in the capital structure= 65%

Before tax cost of debt= 12%

Tax rate= 40%

WACC= 11.88%

WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

0.1188= 12%*0.35* –(1 – 0.40) + 0.65ke

0.1188= 0.0252 + 0.65ke

0.0936= 0.65ke

ke= 0.0936/ 0.65

    = 0.1440*00

    = 14.40%

Therefore, the company’s cost of equity capital is 14.40%.

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