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You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt
You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The before-tax cost of debt capital for the firm is 4 percent. The beta of the company's stock is 1.5. The risk-free rate is 2%, and the market risk premium is 6%. Assume the firm's marginal tax rate is 30%, the company's weighted average cost of capital (WACC) is closest to O 7.7% O 5.9% O 8.2% O 6.4%
Expert Solution
| Weight of equity = 1-D/A |
| Weight of equity = 1-0.4 |
| W(E)=0.6 |
| Weight of debt = D/A |
| Weight of debt = 0.4 |
| W(D)=0.4 |
| Cost of equity |
| As per CAPM |
| Cost of equity = risk-free rate + beta * (Market risk premium) |
| Cost of equity% = 2 + 1.5 * (6) |
| Cost of equity% = 11 |
| After tax cost of debt = cost of debt*(1-tax rate) |
| After tax cost of debt = 4*(1-0.3) |
| = 2.8 |
| WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
| WACC=2.8*0.4+11*0.6 |
| WACC =7.7% |
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