Question

Precision Cuts has a target debt-equity ratio of 0.55. Its cost of equity is 15.4 percent, and its pretax cost of debt is 7.8 percent. If the tax rate is 32 percent, what is the company's WACC?
A) 10.91 percent
B) 11.82 percent
C) 11.28 percent
D) 10.72 percent
E) 10.20 percent

Answer 1

Answer:

B) 11.82 percent

Explanation:

WACC formula = wE*rE + wD*rd(1-tax)

wE = weight of equity

rE = cost of equity

wD = weight of debt

rd = pretax cost of debt

If D/E = 0.55 / 1 , then  D+E = 0.55 +1 = 1.55

therefore wD = 0.55 / 1.55 = 0.3548 or 35.48%

and wE = 1 / 1.55 = 0.6452 or 64.52%

Next, plug in the numbers to the above WACC formula;

WACC = (0.6452*0.154) + [0.3548* 0.078(1- 0.32) ]

= 0.0994 + 0.0188

= 0.1182 or 11.82%

Therefore, the company's WACC = 11.82%