We read your photo as:

Company Y has a target debt to equity ratio of 50%. Currently its book debt to equity ratio is 60% and it expects to revert to the target ratio very soon. The company has an after-tax market cost of debt of 7% and a market cost of equity of 14%. What is the WACC for the company?

Business/Management

ScanSolve AI Answer

Answer

11.67%11.67\%

Step-by-step solution

4 steps

Here's the solution for Question 6:

  1. Determine the weights of debt and equity based on the target debt to equity ratio (D/E).

    The company expects to revert to its target debt to equity ratio of 50% (0.50).
    If Debt (D) / Equity (E) = 0.50, we can express this as D=0.50ED = 0.50E.
    The total capital is D+ED + E.
    The weight of debt (WdW_d) is:

    Wd=DD+E=0.50E0.50E+E=0.50E1.50E=0.501.50=13W_d = \frac{D}{D+E} = \frac{0.50E}{0.50E+E} = \frac{0.50E}{1.50E} = \frac{0.50}{1.50} = \frac{1}{3}

    The weight of equity (WeW_e) is:

    We=ED+E=E0.50E+E=E1.50E=11.50=23W_e = \frac{E}{D+E} = \frac{E}{0.50E+E} = \frac{E}{1.50E} = \frac{1}{1.50} = \frac{2}{3}

  2. Identify the given costs.

    After-tax market cost of debt (Kd(1−T)K_d(1-T)) = 7% = 0.07
    Market cost of equity (KeK_e) = 14% = 0.14

  3. Apply the WACC formula.

    The Weighted Average Cost of Capital (WACC) formula is:

    WACC=Wd×Kd(1−T)+We×KeWACC = W_d \times K_d(1-T) + W_e \times K_e

    Substitute the calculated weights and given costs:

    WACC=13×0.07+23×0.14WACC = \frac{1}{3} \times 0.07 + \frac{2}{3} \times 0.14

  4. Calculate the WACC.

    WACC=0.023333...+0.093333...WACC = 0.023333... + 0.093333... WACC=0.116666...≈11.67%WACC = 0.116666... \approx 11.67\%

    The WACC for the company is 11.67%\boxed{11.67\%}.

Was this helpful?

Try one yourself

A new problem that tests the same skill.

Still stuck on this one?

Ask a follow-up, and the answer starts from this question.

Got a different question?Ask your own question

More Business/Management Questions

QSkolits Corporation has a cost of equity of 11.1% and an aftertax cost of debt of 4.23%. The…QCompany X pays interest to the amount of R1 800 a year on total liabilities of R20 000. It can also…QI. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. ii…QQuestion 2 you're required to calculate tikoloho manufacturing limited weighted average cost of…QPrepare the Debtors Journal and Creditors Journal for the following transactions, assuming a 60%…
See all Business/Management questions →
Got a syllabus? Photograph it and I'll tell you what's due and what's worth the most.