FIN201, there is an error in Slide 10. Once you\'ve reviewed the lecture, go bac

Question

FIN201, there is an error in Slide 10. Once you've reviewed the lecture, go back to Slide 10 and see if you can spot the error.

Slide info is below:

Assume: 100,000 Debt (50%) 100,000 Equity (50%)

Cost of debt 8%

Cost of Equity 12%

Tax rate 40%

Weighted Avarage Cost of Capital=

.50 (.08(-1.40)) + .50 (.12)=

.50 x .024 + .06 = 8.4%

WACC = 8.4%

In the above example we have 100K in debt and 100 k in equity or 50% of debt and 50% of equity. We are given that the cost of equity is 12%, and our cost of debt is 8% and our tax rate is 40%. Plugging the numbers into our formula we get .50 x .08 (1-.40) plus .50 x .12 which equals 8.4% as our weighted average cost of capital. Notice how the WACC is lower because of the inclusion of debt in our capital structure. Including debt in the capital structure lowers our overall weighted average cost of capital.

Explanation / Answer

Weighted average cost of capital=
=0.50*(0.08*(1-0.40))+.50*(0.12)

= 0.50*.048+.06= 8.4

The only mistake in your solution is .50 x .024 which is actually 0.50*0.048.

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