Question

Here is the question: AGN Inc has a WACC of 5.9%, a cost of debt of 4.6% and a cost of equity of 7.2%. AGN's tax rate is 20%. What is AGN's capital structure weight of debt? Report your answer as a decimal rounded to 4 decimal places.

Note: AGN has no preferred equity.

We are using the WACC formula where WACC = (Capital Structure Weight of Equity * Cost of Equity) + (Capital Structure Weight of Debt * Cost of Debt) * (1 - Tax Rate).

We can fill that formula in, but still have unknowns for two variables: Weight of Equity and Weight of Debt. Based on the fact that our end solve is for Debt and that there is a note provided about preferred equity I assume we need to first find a way to solve for Capital Structure Weight of Equity with the given information. We already have Cost of Equity and trying to work backwards to CAPM doesn't help and isn't possible. We don't know the Market Capitalization or market value of the firm to try and calculate the Capital Structure Weight of Equity. It provides the note that we have no preferred equity, but that doesn't change the base formula. If we had preferred equity we could add a third term to the equation, but by saying we don't have any doesn't tell us how much standard equity we actually have. Just that it is all standard.

Any help on how to calculate the Capital Structure Weight of Equity would be greatly appreciated.

Answer 1

(Capital Structure Weight of Equity * Cost of Equity) + (Capital Structure Weight of Debt * Cost of Debt) * (1 - Tax Rate) WACC = Cost of Equity 7.20% Cost of Debt 4.60% Tax rate 20% Also, Capital structure of Equity + Capital structure of debt = 1 So, Capital Structure of Equity =1 - Capital Structure of Debt WACC = (1-Capital structure of Debt)*Cost of Equity + Capital structure of Debt * Cost of Debt * (1-Tax rate) (1-D)*7.20% + D * 4.60%* (1-20%) 5.9% = 5.90% = 7.20% + D (4.60%*0.8 - 7.20%) D = (7.20% - 5.90%)/(7.20%-4.60%*0.8 ) 36.93%