Question

Lannister Manufacturing has a target debt-equity ratio of .55. Its cost of equity is 11 percent, and its cost of debt is 6 percent. If the tax rate is 21 percent, what is the company’s WACC?

Answer 1

8.8%

Step-by-step explanation:

Given

cost of equity is 11 percent = 0.11

cost of debt is 6 percent = 0.06

tax rate 21 percent = 0.21

debt-equity ratio = 0.55

That is debt = 0.55 × equity

We will calculate the weight for debt and equity as

**Weight for equity

Debt + equity = 1

0.55 × equity + equity = 1

1.55 × equity = 1

equity = 1/1.55

equity = 0.6452

*** weight for debt

Debt + equity = 1

Debt + 0.6452 = 1

Debt = 1 - 0.6452

Debt = 0.3548

Now we calculate the weighted average cost of capital WACC

WACC = [weight of debt × (cost of debt × (1 - tax rate)] + weight of equity × cost of equity

= [0.3548 × (0.06 × (1 - 0.21)] + (0.6452 × 0.11)

= 0.01681752 + 0.070972

=0.08778952

WACC = 8.8%