Question

please work out the problem i can donthe graph thank you

Q 17.32. Compute a graph similar to Exhibit 17.2. Use a spreadsheet. Your firm will be worth either $50,000 or $100,000 with equal probabilities. The cost of cap- ital on your debt is given by the formula E(rDebt) 5% + 10%-Wpebt_-but only if the debt is risky. (Hint: The risk-free rate of return is 11.85%. What is the WACC of the firm if it is 100% debt-financed?)

Answer 1

Solution :- Weighted average cost of capital (WACC) of the firm will be Cost of capital on debt only as the firm is completely debt financed.

Cost of debt capital = 5 % + 10 % * Weight of debt (As formula mentioned in question).

= 5 % + 10 % * 1 (Completely debt financing, accordingly, weight of debt will be 100 % or 1).

= 5 % + 10 %

= 15 %.

As the debt is risky, accordingly, the cost of debt capital (as calculated above) 15 % is more than the risk free interest rate of 11.85 % given in the question.

Conclusion :- WACC of the firm = 15.00 %.