A levered firm’s cost of equity capital is 15%. The firm has a market value of...
A levered firm’s cost of equity capital is 15%. The firm has a market value of equity of $15 million and $5 million in outstanding debt at an interest rate of 5%. The corporate tax rate is 35%. What is the firm’s WACC?
Homework Answers
Given
Cost of Equity = 15%
Cost of Debt = 5%
Tax Rate = 35%
Post Tax Cost of Debt = Cost of Debt * (1- Tax rate) = 5* (1-0.35)
Post Tax Cost of Debt = 3.35 %
Now for Weighted average cost of Capital we need to Use the below formula
WACC = Weight of Debt * Post Tax Cost of Debt + Wieght of Equity * Cost of Equity
Now, since the market values of Both Debt and Equity are given we will use the give market values to calculate the debt and Equity weights.
Given. The market value of Debt - $ 5 Million and Market Value of Equity = $15 Million
Therefore Weight of Debt = Debt Market Value / (Debt Market Value + Equity Market Value)
Weight of Debt = $ 5 Million/ ( $ 5 Million + $ 15 Million) = 25%
Therefore Weight of Equity = 100% - Weight of Debt = 100% - 25% = 75%
Now, WACC = 25% *(3.35) + 75%*(15) = 12.0875 %
Therefore the Weighted average cost of Capita is 12.0875 %
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