Question

Currently, Forever Flowers Inc. has a capital structure consisting of 20% debt and 80% equity. Forever's debt currently has an 7% yield to maturity. The risk-free rate (rRF) is 3%, and the market risk premium (rM - rRF) is 8%. Using the CAPM, Forever estimates that its cost of equity is currently 13.5%. The company has a 40% tax rate. What is Forever's current WACC

Answer 1

WACC = 11.6%

Step-by-step explanation:

The weighted average cost of capital (WACC) is the average cost of all the various sources of long-term finance used by a business weighted according to the proportion which each source of finance bears to the the entire pool of fund.

To calculate the weighted average cost of capital, follow the steps below:

Step 1: Calculate cost of individual source of finance

Cost of Equity= 13.5%

After-tax cost of debt:

= (1- T) × before-tax cost of debt

= 7%× (1-0.4)= 4.2%

Step 2 : calculate the proportion or weight of the individual source of finance . (This already given)

Equity = 80%

Debt= 20%

Step 3:Work out weighted average cost of capital (WACC)

WACC = ( 13.5%× 80%) + ( 4.2%× 20%) = 11.64%

WACC = 11.6%