Question

g A company has only two type of capital : debt and equity. It has a target debt-equity ratio of 1.4 . Its cost of equity is 7% , and its cost of debt is 4%. If the tax rate is 26% , what is the company's WACC

Answer 1

WACC = 0.06192 or 6.192%

Step-by-step explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure which can comprise of one or all of the following components namely debt, preferred stock and common stock.

For a company with 2 components of capital structure, the formula for WACC is,

WACC = wD * rD * (1 - tax rate) + wE * rE

Where,

• wD and wE is the weight of debt and equity
• rD and rE is the cost of debt and equity
• we use the after tax cost of debt so we multiply the rD by (1 - tax rate)

Total weight of capital structure = 1 + 4 = 5

Weightage of debt = 1/5

Weightage of equity = 4/5

WACC = 1/5 * 0.04 * (1 - 0.26) + 4/5 * 0.07

WACC = 0.06192 or 6.192%