Question

In: Finance

Hello, I would appreciate if you could return results today, 5.19.20. Thank you. David Ortiz Motors...

Hello,

I would appreciate if you could return results today, 5.19.20. Thank you.

David Ortiz Motors has a target capital structure of 35% debt and 65% equity. The yield to maturity on the company's outstanding bonds is 10%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.84%. What is the company's cost of equity capital? Round your answer to two decimal places. Please provide a simplified formula to calculate the result and step by step how you got the figures.

Expert Solution

Compute the after-tax cost of debt, using the equation as shown below:

After-tax cost = Yield*(1 – Tax rate)

= 10%*(1 – 0.40)

= 6%

Hence, the after-tax cost of debt is 6%.

Compute the cost of equity, using the equation as shown below:

WACC = (Cost of equity*Equity Weight) + (Debt cost*Debt weight)

9.84% = (Cost of equity*65%) + (6%*35%)

9.84% = (Cost of equity*65%) + 2.1%

Rearrange the above-mentioned equation to determine the cost of equity as follows:

Cost of equity = (9.84% - 2.1%)/ 65%

= 7.74%/ 65%

= 11.91%

Hence, the cost of equity is 11.91%

jeff jeffy answered 1 year ago

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