Berkley's has expected earnings before interest and taxes of $3,800. Its unlevered cost of capital is 14.5% and its tax rate is 35%. Berkley's has debt with both a book and a face value of $2,200. This
Debt has a 7.5% coupon and pays interest annually. What is the ﬁrm's weighted average cost of
Capital?
A) 12.48%
B) 12.99%
C) 13.87%
D) 14.14%
E) 14.37%

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of debt:
Cost of debt = coupon rate*(1-tax rate) = 7.5%*(1-0.35) = 4.875%
Next, we can calculate the weighted average cost of capital (WACC):
WACC = (unlevered cost of capital*(1-tax rate)*unlevered value + cost of debt*debt)/(unlevered value + debt)
where unlevered value = EBIT/ unlevered cost of capital

Unlevered value = $3,800/14.5% = $26,206.90

WACC = (14.5%*(1-0.35)*$26,206.90 + 4.875%*$2,200)/($26,206.90 + $2,200) = 13.87%

Berkley's Has Expected Earnings Before Interest and Taxes of $3,800