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Jemisen's has expected earnings before interest and taxes of $6,200. its unlevered cost of capital is 14 percent and its tax rate is 34 percent. the firm has debt with both a book and a face value of $2,500. this debt has a 9 percent coupon and pays interest annually. what is the firm's weighted average cost of capital?

O 14.14 percent
O 13.87 percent
O 14.37 percent
O 12.48 percent
O 13.60 percent

1 Answer

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Jensen's weighted average cost of capital is 11.3%. Option C is the right choice.

The cost of equity is the return investors expect on the firm's common stock.

Formula using to calculate cost of equity :

Cost of equity = (EBIT * (1 - Tax rate) + (Debt * Coupon rate * (1 - Tax rate))) / (EBIT * (1 - Tax rate) + Debt)

where:

EBIT = Expected earnings before interest and taxes

Tax rate = The firm's tax rate

Debt = The book value of the firm's debt

Coupon rate = The interest rate on the firm's debt

Substituting values in this formula

Cost of equity = (6200 * (1 - 0.34) + (2500 * 0.09 * (1 - 0.34))) / (6200 * (1 - 0.34) + 2500) = 0.141

Calculate the cost of debt.

The interest rate the company pays on its debt is known as the cost of debt. In this case, the cost of debt is simply the coupon rate of 9%.

The weight of equity is the proportion of the firm's capital that is financed by equity. The weight of debt is the proportion of the firm's capital that is financed by debt. We can calculate these weights using the following formulas:

Weight of equity = EBIT * (1 - Tax rate) / (EBIT * (1 - Tax rate) + Debt)

Weight of debt = Debt / (EBIT * (1 - Tax rate) + Debt)

Substituting values in this formula

Weight of equity = 6200 * (1 - 0.34) / (6200 * (1 - 0.34) + 2500) = 0.789

Weight of debt = 2500 / (6200 * (1 - 0.34) + 2500) = 0.211

The WACC is the average cost of the firm's capital, taking into account the cost of both equity and debt and the weights of each.

Formula we are using is;

WACC = Cost of equity * Weight of equity + Cost of debt * Weight of debt

Substituting values in this formula

WACC = 0.141 * 0.789 + 0.09 * 0.211 = 0.113

Therefore, Jensen's weighted average cost of capital is 11.3%.

Option C is the right choice.

Question:-

Jensen's has expected earnings before interest and taxes of $6,200. Its unlevered cost of capital is 14 percent and its tax rate is 34 percent. The firm has debt with both a book and a face value of $2,500. This debt has a 9 percent coupon and pays interest annually. What is the firm's weighted average cost of capital?

A. 14.14 percent

B. 13.87 percent

C. 11.3 percent

D. 12.48 percent

E. 13.60 percent

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