Question

The management of the Silver Steel Company learned the firm needed to reevaluate its weighted average cost of capital (WACC) due to a significant issue of debt. The firm now has financed 40%. of its assets with debt and 60% using equity. Calculate the firms WACC where the firms borrowing rate is 6%, it faces a 40% tax rate and the common shareholders require a 15% rate of return:

a. 11.44%

b. 12.44%

c. 6.44%

d. 15%

Answer 1

The calculated weighted average cost of capital (WACC) for Silver Steel Company, considering its capital structure and given rates, is 10.44%, which doesn't match any of the provided options.

Step-by-step explanation:

To calculate the firm's weighted average cost of capital (WACC), we will weight the cost of debt and the cost of equity by the proportion each contributes to the overall capital structure. The cost of debt should be adjusted for the tax shield that debt provides because interest payments are tax-deductible. The formula for WACC is given by:

WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)

Where:

• E = Market value of equity
• D = Market value of debt
• V = E + D = Total market value of the firm's financing (Equity + Debt)
• Re = Cost of equity
• Rd = Cost of debt
• Tc = Corporate tax rate

Given: E/V = 60%, D/V = 40%, Re = 15%, Rd = 6%, Tc = 40%

Substituting the values into the formula, we get:

WACC = (0.60 * 0.15) + (0.40 * 0.06) * (1 - 0.40)

WACC = 0.09 + (0.024 * 0.60)

WACC = 0.09 + 0.0144

WACC = 0.1044 or 10.44%

Therefore, the correct answer is not listed among the options provided.