Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]
After-tax Cost of Debt
Face Value = $1,000
Bond Price = $975
Annual Coupon Amount = $50 [$1,000 x 5%]
Maturity Period = 10 Years
Yield To Maturity [YTM] = Coupon Amount + [(Face Value – Bond Price) / Maturity Years] / [(Face Value + Bond Price)/2]
= $50 + [($1,000 – 975) / 10)] / [($1,000 + 975) / 2]
= [($50 + $2.50) / $987.50]
= [$52.50 / $987.50]
= 0.0533
= 5.33%
After Tax Cost of Debt = Yield to maturity x (1 – Tax Rate)
= 5.33% x [1 – 0.30]
= 5.33% x 0.70
= 3.73%
Cost of Equity
Cost of Equity = Risk-free Rate + (Beta x Market Risk Premium)
= 3% + (1.5 x 6%)
= 3% + 9%
= 12%
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]
= (3.73% x 0.50) + (12% x 0.50)
= 1.87% + 6%
= 7.87%
“Therefore, the firm’s weighted average cost of capital (WACC) would be 7.87%”
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