Question

SIROM Scientific Solutions has $12 million of outstanding equity and $4 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 1. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.
A) 9.70 %
B) 8.73 %
C) 10.67%
D) 9.22%

Answer 1

Answer:

WACC = 9.7%

Explanation:

First lets calculate CAPM to identify the return on equity.

CAPM = Risk free rate + Beta(Market Premium)

CAPM = 4 + 1(8) = 12%

WACC

= weight of equity * return on equity + weight of debt * return on debt * (1 - tax)

This gives,

=(12/12+4) * 0.12 + [(4/12+4) * 0.04 * (1 - 0.30)]

WACC = 0.09 + 0.007 = 9.7%

Hope that helps.

Answer 2

Answer: A) 9.7%

Explanation:

Bank debt cost= bank rate debt

Cost equity = free risk rate + equity beta × market risk premium.

Weight in equity = outstanding equity / (outstanding equity + debt)

Weight in debt = 1 - weight in equity.

WACC = weight in equity × cost of equity + weight in debt × cost of debt × (1 - tax rate)

Cost of equity = 0.04 + 1 × 0.08= 0.12

weight in equity= 12 / (4 + 12) = 0.75 weight in debt = 1 - 0.75 = 0.25

WACC= 0.75 × 0.12 + 0.25 × 0.04 × (1 - 0.30) = 0.097 * 100 = 9.7%