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$3 debt outstanding for every dollar of common stock, CSCO
$3 debt outstanding for every dollar of common stock, CSCO.
Yield to Maturity = 5.46%
Expected return = 4.43%
Given a tax rate of 16%, compute the company’s Weighted Average Cost of Capital. In your own words, interpret that number.
Expert Solution
Weighted average cost of capital (WACC) = Weight of debt * Cost of Debt * (1-Tax rate) + Weight of Equity * Cost of equity
Debt = 3, Equity = 1
So, Weight of debt = Debt / (Debt + Equity)
= 3 / (1+3)
= 0.75
Weight of equity = 1- Debt
= 1 - 0.25
= 0.25
Now,
WACC = 0.75 * 5.46% * (1-16%) + 0.25 * 4.43%
= 3.4398% + 1.1075%
WACC = 4.5473%
The WACC is the cost of capital that the company pays to finance the capital and the company must generate this return so that they can create the value to shareholders.
The company is majorly financed with the debt and the WACC is lower as the company is getting major tax benefit. The cost of equity is lower than the cost of debt, Therefore, the company may isssue more of equity in future.
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