Question

Olsen Outfitters Inc. believes that its optimal capital structure consists of 55% common equity and 45% debt, and its tax rate is 25%. What is the WACC for the last dollar raised to complete the expansion?

A) 10.2%
B) 11.5%
C) 12.8%
D) 13.7%

Answer 1

The WACC is the average cost of financing for a company considering its capital structure. To determine the WACC, multiply the cost of equity by the weight of equity and the cost of debt by the weight of debt, and then sum these costs. Calculate the WACC for each option and select the option that matches the calculated WACC.

Step-by-step explanation:

The WACC (Weighted Average Cost of Capital) is the average cost of financing for a company considering its capital structure. To determine the WACC, we need to multiply the cost of equity by the weight of equity and the cost of debt by the weight of debt, and then sum these costs. The formula for WACC is:

WACC = (Cost of Equity x Weight of Equity) + (Cost of Debt x Weight of Debt)

In this case, the optimal capital structure consists of 55% common equity and 45% debt. Assuming a tax rate of 25%, we can calculate the WACC using the given options:

• Option A: (0.55 x Cost of Equity) + (0.45 x Cost of Debt)
• Option B: (0.55 x Cost of Equity) + (0.45 x Cost of Debt)
• Option C: (0.55 x Cost of Equity) + (0.45 x Cost of Debt)
• Option D: (0.55 x Cost of Equity) + (0.45 x Cost of Debt)

We can calculate the WACC for each option and select the option that matches the calculated WACC.