Answer:
The weighted average cost of capital is 15.167%
Explanation:
In this question, we are interested in calculating the weighted average cost of capital of the firm.
Weighted average cost of capital = (Weight of debt * cost of debt) + (weight of equity * cost of equity)
Firstly, we shall be calculating the cost of equity.
Mathematically,
cost of equity = Risk free rate + (beta * market risk premium)
From the question, the risk free rate is 3% , equity beta is 2 and the market risk premium is 9%
Inputing these values;
Cost of equity = 3% + (2 * 9%) = 3% + 18% = 21%
Now, we proceed to calculate the after tax cost of debt
Mathematically, after tax cost of debt = Cost of debt ( 1- Tax rate)
From the question, cost of debt = 5%
Tax rate = 30% = 30/100 = 0.3
Plugging these values
After tax cost of debt = 5(1-0.3) = 5(0.7) = 3.5%
Weight of debt = bank debt/(outstanding equity + bank debt) = 5/(5+10) = 5/15
Weight of equity = outstanding equity/(bank debt + outstanding equity) = 10/(5+10) = 10/15
Now, plugging these values into the weighted average cost of capital formula, we have;
(5/15 * 3.5) + (10/15 * 21) = 1.167 + 14 = 15.167%
