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Homework answers / question archive / Tandor, Inc
Tandor, Inc. (a U.S. firm) borrows U.S. funds at an interest rate of 9% per year. Its beta is 1.3. The long-term annualized risk-free rate in the U.S. is 2%. The stock market return in the U.S. is expected to be 14% annually. The company's target capital structure is 30% debt and 70% equity. The firm is subject to a 21% corporate tax rate.
(1) Calculate the after-tax cost of debt.
(2) Calculate the cost of equity.
(3) Calculate the weighted average cost of capital
1) Computation of After Tax Cost of Debt:
After-tax Cost of Debt = Cost of Debt*(1-Tax Rate)
= 9%*(1-21%)
= 7.11%
2) Computation of Cost of Euity:
According to CAPM model
Cost of Equity (Ke) = Rf + ( Rm - Rf )
= 2% + 1.3 * ( 14% - 2%)
= 2% + 15.60%
=17.60%
3) Computation of WACC:
WACC = [ Wd * Kd ] + [ We * Ke ]
Here,
Wd & We are the weights of debt & equity finance
Kd & Ke are the after tax cost of debt & Cost of equity
WACC = (30%*7.11%) + (70%*17.60%)
= 2.133% + 12.320%
WACC = 14.453%
