Question

1. (Capital structure) Suppose the weighted average cost of capital of Gadget Company is 10%. If Gadget has a capital structure of 50% debt and 50% equity, a before-tax cost of debt of 5%, and a marginal tax rate of 20%, then its cost of equity capital is closest to: (a) 12% (b) 14% (c) 16%

Please provide solution, also

Answer 1

1)

WACC = Weights * costs

0.1 = 0.5*0.05(1 - 0.2) + 0.5*Cost of equity

0.1 = 0.02 + 0.5*Cost of equity

0.08 = 0.5*Cost of equity

Cost of equity = 0.16 or 16%