Question

6.

What are the WACC weights for debt and equity for an unlevered firm? (this is more of a foundation question, thank you!)

Answer 1

Weighted Average Cost of Capital or WACC of a company is helpful in assessing return an investor could get on an investment in that particular company.

The formula for calculating WACC is given by:

where, R_e = cost of Equity, R_d = Cost of Debt

t_c = corporate tax-rate

E = Value of the Firm's Equity, D = Value of firm's Debt

V = D+E = Value of the firm

An Unlevered firm has Zero Debt i.e., D = 0

So, V = E+D = E+0 = E

For an unlevered firm WACC weights are: E/V = 1 and D/V = 0

Therefore the WACC of an Unlevered firm becomes

So, the WACC of an Unlevered firm is equal to its cost of Equity i.e., WACC_U = R_e