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What is the weighted average cost of capital?
A company has $10 million of outstanding equity and $5 million of bank debt. The bank debt costs 5% per year. The estimated equity beta is 2. If the market risk premium is 7%, the risk-free rate is 4%, and the firm's tax rate is 30%, What is the weighted average cost of capital?
1 Answer
- Don GLv 79 years ago
CAPM, or Required Rate of Return: RF 4% + 2 Beta (MRP 7%) = 4% + 14% = 18%
Debt costs 5%, less tax of 30%, or 3.5%
WACC:
Debt 5.0 mil x 3.5% = 175,000
Equity 10.0 mil x 18% = 1,800,000
Total Capital 15.0 mil
Total Cost of Capital 1,975,000
WACC = 1,975,000 / 15.0 mil = 13.17%
