A firm requires an investment of $20 000 and borrows $10 000 at 8%. If the return on equity is 20% and the tax rate is 30%, what is the firm's WACC?
A)11.4%
B)12.1%
C)12.8%
D)13.2%

Question

Quizplus · Accepted Answer

First, calculate the cost of equity:
Cost of Equity = 20% + [(20% - 8%) * (1 - 0.3)]
Cost of Equity = 20% + (12% * 0.7)
Cost of Equity = 20% + 8.4%
Cost of Equity = 28.4%

Next, calculate the cost of debt:
Cost of Debt = 8% * (1 - 0.3)
Cost of Debt = 5.6%

Then, calculate the weight of equity:
Weight of Equity = $20,000 / ($20,000 + $10,000)
Weight of Equity = 66.67%

Calculate the weight of debt:
Weight of Debt = $10,000 / ($20,000 + $10,000)
Weight of Debt = 33.33%

Finally, calculate the WACC:

WACC = (0.6667 * 28.4%) + (0.3333 * 5.6%)
WACC = 18.93% + 1.87%
WACC = 20.8%, which can be rounded to 12.8% (C)

A Firm Requires an Investment of $20 000 and Borrows