Question

A company has a beta of 1.4, pre-tax cost of debt of 5% and an effective corporate tax rate of 20%. The weight of debt in its capital structure is 60% and the rest is equity. The current risk-free rate is 2% and the expected market return is 7.5%. What is this company's weighted average cost of capital? Answer in percent, rounded to one decimal place.

Answer 1

According to the CAPM,

Cost of Equity = Risk-free Rate + [Beta * (Expected Market Return - Risk-free Rate)]

= 2% + [1.4 * (7.5% - 2%)]

= 2% + [1.4 * 5.5%]

= 2% + 7.7% = 9.7%

WACC = [wD * kD * (1 - t)] + [wE * kE]

= [0.60 * 5% * (1 - 0.20)] + [(1 - 0.60) * 9.7%]

= 2.40% + 3.88% = 6.28%, or 6.3%