Question

Williamson, Inc., has a debt–equity ratio of 2.43. The company's weighted average cost of capital is 11 percent, and its pretax cost of debt is 5 percent. The corporate tax rate is 30 percent.

What would the company’s weighted average cost of capital be if the company's debt–equity ratio were .65 and 1.80? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Cost of debt	5.00%
Tax rate	30%
After tax cost of debt	=5% * (1-30%)
After tax cost of debt	3.500%
Component	Cost	Capital	Weight	Cost * Weight
Debt	3.50%	2.43	70.85%	2.48%
Equity	R	1.00	29.15%	R * 29.15%
		3.43	WACC
2.48% + r*0.2915	11%
r*0.2915=	11%-2.48%
r*0.2915=	8.5200%
r=	8.52%/0.2915
r=	29.23%
WACC if debt equity ratio is 0.65
Component	Cost	Capital	Weight	Cost * Weight
Debt	3.50%	0.65	39.39%	1.38%
Equity	29.23%	1.00	60.61%	17.71%
		1.65	WACC	19.09%
WACC if debt equity ratio is 0.65
Component	Cost	Capital	Weight	Cost * Weight
Debt	3.50%	1.80	64.29%	2.25%
Equity	29.23%	1.00	35.71%	10.44%
		2.80	WACC	12.69%