Question

The following facts describe Larsen & Toubro Ltd’s component costs of capital and capital structure. Based on the information given, calculate Larsen & Toubro’s WACC. Component Costs of Capital (%) Cost of equity based on the CAPM: 15.6 Pretax cost of debt: 8.28 Tax rate: 30 Target weight in capital structure: Equity 80, Debt 20

Answer 1

Larsen & Toubro Ltd's Weighted Average Cost of Capital (WACC) is 13.116%.

Step-by-step explanation:

The Weighted Average Cost of Capital (WACC) is the weighted average of the cost of equity and the after-tax cost of debt, taking into account the company's capital structure.

To calculate WACC:

Calculate the cost of equity using the Capital Asset Pricing Model (CAPM):

Cost of equity = Risk-free rate + Beta * (Market return - Risk-free rate)

Given the cost of equity based on CAPM as 15.6%.

Determine the after-tax cost of debt:

After-tax cost of debt = Pretax cost of debt * (1 - Tax rate)

Given the pretax cost of debt as 8.28% and a tax rate of 30%.

Compute the WACC using the formula:

WACC = (Weight of equity * Cost of equity) + (Weight of debt * After-tax cost of debt)

Given the target weights in the capital structure: Equity 80% and Debt 20%.

Applying the formula:

WACC = (0.80 * 15.6%) + (0.20 * 8.28% * (1 - 0.30))

WACC = (0.1248) + (0.02064)

WACC = 0.14544

Therefore, Larsen & Toubro Ltd's Weighted Average Cost of Capital (WACC) is 14.544%.