Question

A firm is funded with $200 million in debt and $600 million in equity. The YTM on the firm's bonds is 10%. The tax rate is 30%. The firm has a beta of 1.25. The risk free rate is 2% and the market risk premium is 12%. The weighted average cost of capital for the firm is:

Answer 1

Answer:

14.50%

Explanation:

Proportion of debt the firm uses = $200 / $200 + $600 = 0.25

Proportion of equity the firm uses = 1 - 0.25 = 0.75

WACC  = proportion of debt x cost of debt x (1 - tax rate) + proportion of equity x cost of equity

cost of equity = risk free rate + (beta x market risk premium)

2% + (1.25 x 12%) = 17%

0.25 x 10% x (1 - 0.30) + 0.75 x 17%

1.75 + 12.75% = 14.50%