Question

bedazzled inc. typically uses equity as their main source of funding and only raises funds using debt for about 10% of their total funding. their before-tax cost of debt was recently estimated to be 5% while the after-tax cost of their equity was recently estimated at 12%. estimate the firm's wacc. assume the firm faces a tax rate of 40%. (hint: be careful if you costs are before-tax or after-tax.)

Answer 1

To estimate the firm's WACC, calculate the weighted average of the cost of debt and cost of equity. The WACC is 7.7%.

Step-by-step explanation:

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

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

Given that the firm uses equity as its main source of funding and debt for only 10% of its total funding, the weights would be 0.9 for equity and 0.1 for debt. The before-tax cost of debt is 5% and the after-tax cost of equity is 12%. Since the firm has a tax rate of 40%, we can calculate the WACC as:

WACC = (0.1 times 5%) + (0.9 times 12% times (1 - 0.4))

WACC = 0.5% + 7.2% = 7.7%

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by the external market and not by management.

The weighted average cost of capital (WACC) is the average rate that a business pays to finance its assets. It is calculated by averaging the rate of all of the company's sources of capital (both debt and equity), weighted by the proportion of each component.