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Question: A company is 40% nanced by risk-free debt. The interest rate…

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A company is 40% nanced by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of
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the company�s common stock is .5.
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Risk Free Debt Interest Rate Market Risk Premium Beta Taxes
40% 10% 8% 0.5 35%
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a.����� What is the company cost of capital? messaging rates may apply.

b.����� What is the after-tax WACC, assuming that the company pays tax at a 35% rate?

Step 1:
r(d)= F
r(e)= C
D/V C
E/V C

Step 2:
a. Formula Calculation
Cost of Capital T C

b. WACC T C
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Expert Answer

Mike J answered this

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2 answers

Step 1.

r(d) = 10%

r(e) = r(d) + (beta * risk premium) = 0.1 + (0.5 * 0.08) = 14%

D/V = Risk Free Debt = 40%

E/V = 1 - Risk Free Debt = 60%

Step 2

Cost of Capital = r(d) * D/V + r(e) * E/V = 0.1 * 0.4 + 0.14 * 0.6 = 12.4%

WACC = (1 - Tc) * r(d) * D/V + r(e) * E/V = (1 - .35) * 0.1 * 0.4 + 0.14 * 0.6 = 11.0%
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