Question

David Ortiz Motors has a target capital structure of 45% debt and 55% equity. The yield to maturity on the company's outstanding bonds is 12%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 11.35%. What is the company's cost of equity capital

Answer 1

Answer:

the company's cost of equity capital is 14.75 %.

Explanation:

WACC = ke × (E/V) + kd × (D/V)

Where,

ke = cost of equity

    = this is unknown

E/V = Weight of Equity

      = 55%

kd = cost of debt

     = Interest × ( 1 - tax rate)

     = 12% × ( 1 - 0.40)

     = 7.20 %

D/V = Weight of Debt

       = 45%

Therefore,

WACC = ke × (E/V) + kd × (D/V)

11.35% = 55%ke + 7.20 % × 45%

11.35% = 55%ke + 3.24 %

55%ke = 8.11 %

ke = 14.75 %