The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt o

Question

The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate of 32 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40? (Hint: remember that the debt-equity ratio is the book value of debt divided by the book value of equity. To simplify solving this problem, just pick any two dollar numbers that give a 0.40 debt-equity ratio, like $0.40 for debt and $1.00 for equity, and use those to calculate the weights of debt and equity for the WACC. )

Explanation / Answer

We know WACC = Kd*(1-T)*Wd + Ks*Ws where Ws&Wd are weights of Equity & Debt, Kd & Ks are cost of Debt & Cost of equity. We also have D/E = 0.4 or D=0.4*E We can also write WACC eqn as WACC = Kd*(1-T)*(D/(D+E)) + Ks*(E/(D+E)) ie WACC = 7.7%*(1-32%)*(0.4E/1.4E) + 15.8%*(E/1.4E) ie WACC = 7.7%*(1-32%)*(0.4/1.4) + 15.8%*(1/1.4) ie WACC = 12.78%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.