Gaucho Services starts life with all-equity financing and a cost of equity of 14%. Suppose it refinances to the following market-value capital structure:
| Debt (D) | 45% | at rD = 9.4% |
| Equity (E) | 55% | |
Use MM’s proposition 2 to calculate the new cost of equity. Gaucho
pays taxes at a marginal rate of Tc = 30%.
Calculate Gaucho’s after-tax weighted-average cost of capital.
(Do not round intermediate calculations. Enter your answer
as a percent rounded to 2 decimal places.)
Homework Answers
| Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate) |
| Levered cost of equity = 14+0.818181818181818*(14-9.4)*(1-0.3) |
| Levered cost of equity = 16.63 |
| Weight of equity = 1-D/A |
| Weight of equity = 1-0.45 |
| W(E)=0.55 |
| Weight of debt = D/A |
| Weight of debt = 0.45 |
| W(D)=0.45 |
| After tax cost of debt = cost of debt*(1-tax rate) |
| After tax cost of debt = 9.4*(1-0.3) |
| = 6.58 |
| WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
| WACC=6.58*0.45+16.63*0.55 |
| WACC =12.11% |
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