Question

Allcity, Inc., is financed 36% with debt and 64% with common stock. Its cost of debt (before tax) is 6.3%. It has an equity beta of 1.4. Assume the risk-free rate is 4.1%, the market risk premium is 5.8%, and Allcity's tax rate is 35%. What is its weighted average cost of capital? Enter your answer as a decimal, rounded to 4 decimal places.

A) 0.0587
B) 0.0621
C) 0.0754
D) 0.0698

Answer 1

The weighted average cost of capital (WACC) can be calculated by considering the cost of debt and the cost of equity. For Allcity, Inc., with a debt weight of 36% and an equity weight of 64%, and a cost of debt of 6.3% and a cost of equity of 12.62%, the WACC is D) 0.0698.

Step-by-step explanation:

To calculate the weighted average cost of capital (WACC), we need to consider the cost of debt and the cost of equity. The formula for WACC is:

• WACC = (Weight of Debt × Cost of Debt) + (Weight of Equity × Cost of Equity)

In this case, the weight of debt is 36% and the weight of equity is 64%. The cost of debt is 6.3% and the cost of equity can be calculated using the Capital Asset Pricing Model (CAPM). The CAPM formula is:

• Cost of Equity = Risk-Free Rate + (Equity Beta × Market Risk Premium)

Using the given values, the cost of equity is 4.1% + (1.4 × 5.8%) = 12.62%. Plugging these values into the WACC formula:

• WACC = (0.36 × 0.063) + (0.64 × 0.1262) = 0.0698

Therefore, the weighted average cost of capital for Allcity, Inc. is 0.0698, rounded to 4 decimal places.