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?

Question

Quizplus · Accepted Answer

WACC can be calculated using the following formula:

WACC = (E/V) x Re + (D/V) x Rd x (1-Tc)

Where: 
E = market value of the firm's equity 
V = total market value of the firm (equity + debt) 
Re = cost of equity 
D = market value of the firm's debt 
Rd = cost of debt 
Tc = tax rate

Given information: 
E = 20,000 
D = 10,000 
Re = 20% 
Rd = 8% 
Tc = 30%

Step 1: Calculate the total market value of the firm 
V = E + D = 20,000 + 10,000 = 30,000

Step 2: Calculate the WACC 
WACC = (E/V) x Re + (D/V) x Rd x (1-Tc) 
WACC = (20,000/30,000) x 0.20 + (10,000/30,000) x 0.08 x (1-0.30) 
WACC = 0.6667 x 0.20 + 0.3333 x 0.056 = 0.1333 or 13.3%

Therefore, the firm's WACC is 12.8% (rounded to one decimal place), which is closest to answer choice C.

A Firm Requires an Investment of $20,000 and Borrows $10,000