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A firm has expected earnings before interest and taxes of $1,700. Its unlevered cost of capital...

A firm has expected earnings before interest and taxes of $1,700. Its unlevered cost of capital is 13 percent and its tax rate is 34 percent. The firm has debt with both a book and a face value of $2,700. This debt has a 7 percent coupon and pays interest annually. What is the firm's weighted average cost of capital?

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Value of Unlevered Firm = EBIT * (1 - Tax Rate) / Unlevered Cost of Equity
Value of Unlevered Firm = $1,700 * (1 - 0.34) / 0.13
Value of Unlevered Firm = $8,630.77

Value of Levered Firm = Value of Unlevered Firm + Tax Rate * Value of Debt
Value of Levered Firm = $8,630.77 + 0.34 * $2,700
Value of Levered Firm = $9,548.77

Value of Equity = Value of Levered Firm - Value of Debt
Value of Equity = $9,548.77 - $2,700
Value of Equity = $6,848.77

Weight of Debt = Value of Debt / Value of Levered Firm
Weight of Debt = $2,700 / $9,548.77
Weight of Debt = 0.28276

Weight of Equity = Value of Equity / Value of Levered Firm
Weight of Equity = $6,848.77 / $9,548.77
Weight of Equity = 0.71724

Debt-Equity Ratio = Value of Debt / Value of Equity
Debt-Equity Ratio = $2,700 / $6,848.77
Debt-Equity Ratio = 0.39423

Cost of Debt = Interest Rate
Cost of Debt = 7.00%

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity Ratio
Levered Cost of Equity = 0.1300 + (0.1300 - 0.0700) * (1 - 0.34) * 0.39423
Levered Cost of Equity = 0.1300 + 0.0156
Levered Cost of Equity = 0.1456 or 14.56%

WACC = Weight of Debt * Cost of Debt * (1 - Tax Rate) + Weight of Equity * Cost of Equity
WACC = 0.28276 * 7.00% * (1 - 0.34) + 0.71724 * 14.56%
WACC = 11.75%

jeff jeffy answered 1 year ago
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