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Homework answers / question archive / A company has determined that its optimal capital structure consists of 45 percent debt and the rest is equity

A company has determined that its optimal capital structure consists of 45 percent debt and the rest is equity

Finance

A company has determined that its optimal capital structure consists of 45 percent debt and the rest is equity. Given the following information, calculate the firm's weighted average cost of capital.kd = 5.8 %Tax rate = 28 %P0 = $ 28.69 Growth = 5.7 %D1 = $ 1.82 Show your answer to the nearest .1%

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Computation of Weighted Average Cost of Capital (WACC):

First we calculate Share Price using Gordon model:

Share price (P0) = D1 / k -g

$28.69 = $1.82 / k - 5.7%

$28.69* (k - 5.7%) = $1.82

k - 5.7% = $1.82 / $28.69

k - 0.057 = 0.0634

k = 0.0634 + 0.057

k = 12.04%

So, cost of equity is 12.04%.

Now, we will calculate weighted average cost of capital (WACC) by the following formula:

WACC = we * re + wd* rd * (1 - t)

WACC = ((55% * 12.04%) + (45% * 5.8%) * ( 1 - 28%))

WACC = 6.62% + (2.61% * 72%)

WACC = 6.62% + 1.88% = 8.50%

So, weighted average cost of capital is 8.50%

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