A firm is funded with $500 million in equity and $475 million in debt

Finance Dec 23, 2020

A firm is funded with $500 million in equity and $475 million in debt. The yield to maturity on bonds issued by the firm is 7.85%. The tax rate is 40%. The firm has a beta of 1.15. The risk-free rate is 5%, and the market risk premium is 9%. The weighted average cost of capital for this firm is:

Expert Solution

Cost of debt after-tax=YTM*(1-tax rate)

=7.85*(1-0.4)

=4.71%

Cost of equity=risk free rate+Beta*market risk premium

=5+(9*1.15)

=15.35%

Total value=(500+475)=$975 million

WACC=Respective cost*Respective weight

=(500/975*15.35)+(475/975*4.71)

=10.17%(approx)

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