Question

Cinco De Mayo has a target debt-equity ratio of 0.58. (Hint: The yield to maturity on its bonds is 11 percent. Its cost of equity is 16 percent. The corporate income tax rate is 32 percent. Calculate the WACC for this company. Multiple Choice 0 1287% 12.87% 0 13.52% 3.52% 0 11.06% 0 10.61% 0 12.23%

Answer 1

After tax cost of debt = yield to maturity* (1- tax rate)

= 11% * ( 1-32%)

= 7.48%

Cost of equity = 16%

debt-equity ratio = 0.58

Let Equity be x

Debt Equity Ratio = Debt / Equity

Hence, Debt = 0.58x

Total Assets = Debt + Equity

= 0.58x + x

=1.58x

WACC = Cost of equity * weight of equity + cost of debt * weight of debt

= [16% * ( x/1.58x) ] + [7.48% * (0.58x/1.58x)]

= 10.12658228+2.745822785

= 12.87240506%

= 12.87%

Hence the correct answer is 12.87%