A firm uses only debt and equity in its capital structure. The firm's weight of debt is 75 percent. The firm could issue new bonds at a yield to maturity of 12 percent and the firm has a tax rate of 21 percent. If the firm's WACC is 13 percent, what is the firm's cost of equity?
A) 38.29 percent
B) 36.00 percent
C) 23.56 percent
D) 4.00 percent

Question

Quizplus · Accepted Answer

The firm's Weighted Average Cost of Capital (WACC) is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E is the market value of the equity, D is the market value of the debt, V = E + D is the total market value of the firm's financing (equity and debt), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Given that the weight of debt (D/V) is 75% or 0.75, the weight of equity (E/V) is 25% or 0.25, Rd is 12%, and Tc is 21%. The WACC is given as 13%. Plugging the values into the WACC formula and solving for Re (cost of equity) gives us the cost of equity as 23.56%.

A Firm Uses Only Debt and Equity in Its Capital