Question

The Black Bird Company plans an expansion. The expansion is to be financed by selling $49 million in new debt and $22 million in new common stock. The before-tax required rate of return on debt is 10.06% percent and the required rate of return on equity is 18.31% percent. If the company is in the 34 percent tax bracket, what is the weighted average cost of capital?

Answer 1

Total firm value= $49 + $22

                        = $71

Weight of debt in the firm capital= $49/ $71

                                                                = 0.6901*100

                                                                = 69.01%

Weight of equity in the firm capital= $22/ $71

                                                                   = 0.3099*100

                                                                   = 30.99%

WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC= 0.6901*10.06%*(1 – 0.34) + 0.3099*18.31%

           = 0.6901*6.6396% + 0.3099*18.31%

           = 4.5820% + 5.6743%

           = 10.2563% 10.26%.

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