Final answer:
The WACC of a company with a 0.5 debt to equity ratio, a return on equity of 7%, a return on debt of 6%, and a 25% corporate tax rate is calculated to be approximately 6.67%, which is not listed among the given choices.
Step-by-step explanation:
To calculate the Weighted Average Cost of Capital (WACC) of a company with a 0.5 debt to equity ratio, a return on equity (ROE) of 7%, a return on debt of 6%, and subject to a 25% corporate tax rate, you can use the following formula:
WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
Where E is the market value of the equity, D is the market value of the debt, V is the total market value of the company's financing (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate.
In this case, a debt equity ratio of 0.5 means that for every $1 of equity, there is $0.5 of debt. This implies that the ratio of debt to total financing (D/V) is 0.5/1.5 (since Debt + Equity = 1 + 0.5 = 1.5 parts) and the ratio of equity to total financing (E/V) is 1/1.5.
Using the values given:
- E/V = 1/1.5
- D/V = 0.5/1.5
- Re = 7%
- Rd = 6%
- Tc = 25%
Plug in the values into the WACC formula:
WACC = (1/1.5) * 0.07 + (0.5/1.5) * 0.06 * (1 - 0.25)
WACC = 0.0467 + 0.02 = 0.0667 or 6.67%
The closest option given to this calculated WACC is 0.067 or 6.7%, which suggests that the correct answer is not listed among the multiple choice options.