Question

A company has a target debt-equity ratio of 0.57. The yield to maturity on its bonds is 11 percent. Its cost of equity is 17 percent. The corporate income tax rate is 32 percent. Calculate the WACC for this company.

Answer 1

13.54%

Step-by-step explanation:

Debt Equity Ratio (Debt/Equity)=0.57

Yield to Maturity (YTM) on bonds (Cost of Debt) (Kd) = 11%

Cost of Equity (Ke) = 17%

Income Tax Rate= 32%

Computation of WACC

Particulars Proportion (1) Cost (2) Weighted Cost (1*2)

Equity 0.6369 17 10.8273

Bond (Debt) 0.3631 7.48 2.7160

Total 1 13.5433

Therefore, the WACC of Company= 13.54%

Working Note 1

Computing Proportion

Debt/Equity=0.57

Therefore Debt= 0.57 Equity

Lets assume Equity = 10

So Debt = 5.7

Hence, Proportion is as follows:

Equity= 10/15.7 =0.6369

Debt= 5.7/15.7 = 0.3631

Working Note 2

After tax cost of Debt = 11 * (1 - 0.32)

After tax cost of Debt = 11 * 0.68

After tax cost of Debt = 7.48%