Question

company A has a market value of debt equal to 50m and value of equity 50m. assume the SML holds and has a risk premium of 6% and rf = 5%. company A has a beta of 0.8. The interest paid on debt is 15% . calculate the WACC (Appropriate discount rate)

Answer 1

Solution:
	WACC of the company is            12.40%
Working Notes:
	Calculation of WACC
First	The cost of debt is 15%,
	Tax rate = not given = 0% (assumed)
	After tax cost of debt (Kd) = Cost of debt x (1- tax rate)
	After tax cost of debt (Kd) = 15% x (1- 0%)
	After tax cost of debt (Kd) = 15%
2nd	Now we calculate Cost of equity using SML Method
	Cost of common equity (Ke)= rf + (rm - rf) x B
	rf = risk free rate = 5%
	(rm - rf) = market risk premium = 6%
	Beta = 0.80
	Cost of common equity (Ke)= rf + (rm - rf) x B
	Cost of common equity (Ke)= 5% + 6% x 0.80
	Cost of common equity (Ke)= 9.80%
	WACC= Ke x E/V + Kd   x D/V
	Debt =D = 50m
	Equity =E = 50m
	V= market value of the company= E+D= 50+50=100m
	E/V =50/100= 0.50
	D/V =50/100= 0.50
	WACC= Ke x E/V + Kd   x D/V
	WACC= 9.80% x 0.50 + 15% x 0.50
	WACC=12.40%
Please feel free to ask if anything about above solution in comment section of the question.