Question

granite works maintains a debt-equity ratio of .65 and has a tax rate of 32 percent. the pretax cost of debt is 9.8 percent. there are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. the current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. this year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. using an average expected cost of equity, what is the weighted average cost of capital?

Answer 1

The weighted average cost of capital (WACC) is 11.13%.

Step-by-step explanation:

The weighted average cost of capital (WACC) is a measure of a company's average cost of financing its operations, including both debt and equity.

To calculate the WACC, we need to calculate the cost of debt and the cost of equity, and then weight them according to the company's debt-equity ratio.

First, let's calculate the cost of debt.

The pretax cost of debt is given as 9.8%.

Since the tax rate is 32%, the after-tax cost of debt is

9.8% * (1-0.32) = 6.66%.

Next, let's calculate the cost of equity.

The cost of equity is calculated using the Capital Asset Pricing Model (CAPM).

The CAPM formula is:

Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium

Given that the risk-free rate is 3.6%, the beta is 1.2, and the market risk premium is 8.5%, the cost of equity is

3.6% + 1.2 * 8.5% = 14.2%.

Now, let's calculate the weighted average cost of capital. The WACC formula is:

WACC = (Equity / Total Capital) * Cost of Equity + (Debt / Total Capital) * Cost of Debt

Given that the debt-equity ratio is 0.65, the WACC is

(0.65 * 14.2%) + (0.35 * 6.66%) = 11.13%.