Question

The following data pertains to Michalko Corp. Assuming that the risk-free rate is 4.2% and the market risk premium is 6.2%, calculate Michalko's weighted-average cost of capital.
Michalko Corp.

Total Assets $14,680
Interest-Bearing Debt $19,100
Average borrowing rate for debt 11%
Common Equity:
Book Value $5,120
Market Value $25,700
Marginal Income Tax Rate 40%
Market Equity Beta 1.25

Answer 1

Answer:

Michalko's weighted-average cost of capital is 9.65 %.

Explanation:

Weighted Average Cost of Capital (WACC) is the return that is required by providers of Long term sources of finance.

WACC = Ke x (E/V) + Kp x (P/V) + Kd x (D/V)

Therefore,

Ke = Cost of Equity

     = Return on Risk free Security + Beta x (Return on Market Portfolio -       Return on Risk free Security)

     = 4.2% + 1.25 × 6.2%

     = 11.95 %

E/V = Market Weight of Equity

      = $25,700/ ($25,700 + $19,100)

      = 0.57

Kd = Cost of Debt

  = Market Interest x ( 1 - tax rate)

  = 11% × (1 - 0.40)

  = 6.60 %

D/V = Market Weight of Debt

      = $19,100/($25,700 + $19,100)

      = 0.43

Thus,

WACC = Ke x (E/V)  + Kd x (D/V)

           = 11.95 % × 0.57 + 6.60 % × 0.43

           = 9.65 %