Question

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 11%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.39%. What is the company's cost of equity capital? Round your answer to two decimal places.

Answer 1

Cost of Equity is 11.25%

Step-by-step explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of equity x Weightage of equity )+ ( Cost of debt ( 1- t) x Weightage of debt )

9.39% = ( Cost of equity x 60% )+ ( 11% ( 1 - 0.4) x 40% )

9.39% = ( Cost of equity x 60% )+ ( 11% ( 0.6) x 40% )

9.39% = ( Cost of equity x 60% )+ ( 6.6% x 40% )

9.39% = ( Cost of equity x 60% )+ 2.64%

9.39% - 2.64% = Cost of equity x 60%

6.75% = Cost of equity x 60%

Cost of equity = 6.75% / 60%

Cost of equity = 11.25%