Question

Bruin Inc. is investing in a new project with similar risk profile as its other projects. Considering that the cost of equity is 11.7%, the cost of debt is 6.6% and the company's tax rate is  35%, what is the appropriate discount rate for the project if the debt/equity ratio is 0.5?

Select one:

a. 9.1500%

b. 8.3000%

c. 9.2300%

d. 7.9950%

e. 6.7600%

Answer 1

Correct answer is C

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In this question we need to calculate WACC.

Debt = 1

Equity = 2

Debt + equity = 3

Debt % in capital = 1/3 = 33.33%

Equity % in capital = 2/3 = 66.67%

The weighted average cost of capital (WACC) is a financial ratio that calculates a company’s cost of financing and acquiring assets by comparing the debt and equity structure of the business. In other words, it measures the weight of debt and the true cost of borrowing money or raising funds through equity to finance new capital purchases and expansions based on the company’s current level of debt and equity structure.

WACC = (We* Re) + (Wp * Rp) + (Wd * Rd) (1 - t)

Where,

                  Equity portion (We) = 66.67%

                  Preference share portion (Wp) = 0%

                  Debt portion (Wd) = 33.33%

                  Cost of equity (Re) = 11.7%

                  Cost of preference share (Rp) = 0%

                  Cost of debt (Rd) = 6.6%

                  Tax rate (t) = 35%

Let's put all the values in the formula,

WACC = (0.6667 * 0.117) + (0 * 0) + (0.3333 * 0.066)*(1 - 0.35)

                = 0.078 + 0 + 0.022 * 0.65

                = 0.078 + 0.0143

                = 0.0923

So WACC is 9.23%

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