Question

The firm's tax rate is 34%. The firm's pre-tax cost of debt is 8%; the firm's debt-to-equity ratio is 3; the risk-free rate is 3%; the beta of the firm's common stock is 1.5; the market risk premium is 9%.

Calculate the weighted average cost of capital.

A) 8.09%

B) 8.51%

C) 9.05%

D) 9.57%

E) 9.76%

Answer 1

Answer:

A)8.09%

Explanation:

First we have to calculate the Cost of equity of firm using Capital Asset Pricing Model(CAPM).The formula of CAPM is given below:

RE = RF + β (RM – RF)

RE = the cost of equity for a firm’s share.

RF = the risk-free rate of return.

β = the beta factor for the firm’s common stock.

RM – RF=The market risk premium.

Using the above formula  Cost of equity of the Firm can be calculated as:

Cost of equity=RE=3%+1.5*9%=16.5%

Debt value of firm=3

Equity value of firm=1

WACC=(Debt value of firm*post tax cost of debt+Equity value of firm*post tax cost of equity)/(Debt value of firm+Equity value of firm)

WACC=(3*8%*66%+1*16.5%)/3+1

         = 32.34%/4

        =8.09%

so the answer is A)8.09%