Question

Hi-Octane Oil Company has a debt-equity ratio of 0.25. The company uses no preferred stock in...

Hi-Octane Oil Company has a debt-equity ratio of 0.25. The company uses no preferred stock in its capital structure. If the cost of equity is 14.4% and the after-tax cost of debt is 6.2%, what is the company's weighted average cost of capital?

a. 6.20

b. 8.25%

c. 12.35%

d. 12.76%

e. 14.4%

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Homework Answers

Answer #1

>>>>>

Debt + Equity = 1

Equity = 1- Debt

Debt equity ratio = 0.25

Debt / Equity = 0.25

Debt / (1 - Debt) = 0.25

1.25 Debt = 0.25

Debt = 0.2

Equity = 1- Debt = 1-0.2 = 0.8

>>>>>

Weight of Debt = Wd= 0.2

Weight of Equity = We = 0.8

After Tax cost of debt = rd = 6.2%

After Tax cost of Equity = re = 14.4%

>>>>>

Weighted Average Cost of Capital = [Wd*rd] + [We*re]

=[0.2 * 6.2%] + [0.8 *14.4%]

= 1.24% + 11.52%

= 12.76%

Company's Weighted Average Cost of Capital is 12.76%

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