Question

A company's stock market value is 80 bn, and the value of its debt is 20 bn. The yield on its debt is 6%. The corporate tax rate is 30%. It estimates that the required return on its stock is 12%. What is its weighted average cost of capital?

Answer 1

The company's weighted average cost of capital (WACC) is calculated using the formula WACC = (E/V) * Re + (D/V) * Rd * (1 - T), where E is the market value of equity, D is the market value of debt, V is the total market value of financing, Re is the required return on equity, Rd is the cost of debt, and T is the corporate tax rate. By inputting the given values, the WACC is determined to be 10.44%.

Step-by-step explanation:

The student's question pertains to the calculation of a company's weighted average cost of capital (WACC). The WACC is a key financial metric used to assess the average cost of a company's capital, including both equity and debt.

The formula to calculate WACC is:

WACC = (E/V) * Re + (D/V) * Rd * (1 - T)

• E = Market value of equity (stock)
• D = Market value of debt
• V = Total market value of the company's financing (E + D)
• Re = Required return on the company's equity
• Rd = Cost of debt (yield on the company's debt)
• T = Corporate tax rate

Using the provided values:

E = 80 bn, D = 20 bn, Re = 12%, Rd = 6%, T = 30%

V = E + D = 80 bn + 20 bn = 100 bn

Now we can calculate the WACC:

WACC = (80/100) * 12% + (20/100) * 6% * (1 - 0.30)

WACC = (0.8) * 12% + (0.2) * 6% * (0.7)

WACC = 9.6% + 0.84%

WACC = 10.44%

Therefore, the company's WACC is 10.44%.