Question

Tulloch Manufacturing has a target debt–equity ratio of .62. Its cost of equity is 14.8 percent, and its pretax cost of debt is 9.8 percent. If the tax rate is 38 percent, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) WACC %

Answer 1

Answer:

11.46%

Explanation:

WACC is the weighted average cost of capital employed from different sources i.e. common equity, preferred equity and debt

To calculate WACC, the weighted average costs of each kind of capital employed is added so the formula becomes:

WACC =(D x (1 - Tax) x %D) + (P x %P) + (E x %E)

D = cost of debt

P = cost of preferred equity

E = cost of common equity

%D = Debt / total capital

%P = Preferred equity / total capital

%E = Common equity / total capital

Interest expense is tax deductible therefore it is adjusted for tax when calculating WACC

Since there is no preferred equity in the question the formula will become:

WACC =(D x (1 - Tax) x %D) + (E x %E)

Solution:

Debt to equity = 0.62

Debt + Equity = 1.62 ( 0.62 + 1 Since Debt is $0.62 for every $1 of equity)

%D = 0.62/1.62 = 38.27%

%E = 1/1.62 = 61.73%

D = 9.8%

E = 14.8%

Using the above formula, we can calculate WACC

WACC = (9.8% x (1 - 38%) x 38.27%) + (14.8% x 61.73%)

WACC = 0.1146 or 11.46%

*Values rounded to two decimal points*