Question

WACC.  Eric has another​ get-rich-quick idea, but needs funding to support it. He chooses an​ all-debt funding scenario. He will borrow ​$2,886 from​ Wendy, who will charge him 6​% on the loan. He will also borrow ​$2, 278 from​ Bebe, who will charge him 8​% on the​ loan, and ​$836 from​ Shelly, who will charge him 14​% on the loan. What is the weighted average cost of capital for​ Eric? What is the weighted average cost of capital for​ Eric?

Answer 1

In the first step, we will calculate the weight of each person's debt by dividing the amount borrowed from each person by the total amount borrowed:

Total amount borrowed = $2286 + $2278 + $836 = $5400

Weight of total amount borrowed:

Wendy (w1): $2286 / $5400 = 0.4233

Bebe (w2): $2278 / $5400 = 0.4219

Shelly (w3): $836 / $5400 = 0.1548

In the next step we will use the following formula to calculate weighted average cost of capital;

The formula for weighted average cost of capital is:

Weighted average cost of capital = w1 * r1 + w2 * r2 + w3 * r3

where, w1,w2 and w3 are the weights and r1,r2 and r3 are the costs of the debts.

Given:

r1 = Wendy's cost = 6%

r2 = Bebe's cost = 8%

r3 = Shelly's cost = 14%,

Putting the given values in the above formula, we get,

Weighted average cost of capital = (0.4233 * 6%) + (0.4219 * 8%) + (0.1548 * 14%)

Weighted average cost of capital = 0.025398 + 0.033752 + 0.021674

Weighted average cost of capital = 0.080824 or 8.0824%