How would you calculate the cost of equity, cost of debt, weight of debt and weight of debt and weighted cost of capital with the following given information

Business Sep 28, 2020

How would you calculate the cost of equity, cost of debt, weight of debt and weight of debt and weighted cost of capital with the following given information.

debt-to-equity ratio = .25
beta of common = 1.15
beta of debt = .3
market risk of premium = 10%
risk-free rate = 6%
corporate tax rate = 35%
weight of equity = 80%

Expert Solution

Rf=Risk free rate = 6%
Beta of common stock =1.15
Market risk premium = (Rm-Rf)=10%

Cost of Equity=Rf+beta of stock*(Rm-Rf)=6%+1.15*10%=17.5%

Pre-tax Cost of Debt = Rf+Beta of debt*(Rm-Rf)=6%+0.3*10%=9%

Cost of Debt = Pre tax cost of debt*(1-tax rate)=9%*(1-35%)= 5.85%

Weight of Debt = 1-Weight of equity = 1-0.8=0.2

Weighted average cost of capital = weight of debt * cost of debt + weight of equity * cost of equity
=0.2*5.85%+0.8*17.5%
=15.17%

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