Calculate the weighted average cost of capital for Limp Linguini Noodle Makers Inc. under the following conditions:
*The capital structure is 40% debt and 60% equity.
*The before-tax cost of debt (which includes flotation costs) is 20% and the firm is in the 40% tax bracket.
*The firm's beta is 1.7.
*The risk-free rate is 7% and the market risk premium is 6%.

Question

Calculate the weighted average cost of capital for Limp Linguini Noodle Makers Inc. under the following conditions: 
*The capital structure is 40% debt and 60% equity.
*The before-tax cost of debt (which includes flotation costs) is 20% and the firm is in the 40% tax bracket.
*The firm's beta is 1.7.
*The risk-free rate is 7% and the market risk premium is 6%.

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is calculated as follows: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E/V is the proportion of equity in the firm's capital structure, Re is the cost of equity, D/V is the proportion of debt in the firm's capital structure, Rd is the cost of debt, and Tc is the corporate tax rate. The cost of equity (Re) can be calculated using the Capital Asset Pricing Model (CAPM), which is Re = Rf + Beta * (Rm - Rf), where Rf is the risk-free rate, Beta is the beta of the firm, and Rm is the market risk premium. Plugging in the given values: Re = 7% + 1.7 * 6% = 17.2%. The after-tax cost of debt (Rd * (1 - Tc)) is 20% * (1 - 0.4) = 12%. Therefore, WACC = (0.6 * 17.2%) + (0.4 * 12%) = 10.32% + 4.8% = 15.12%.

Calculate the Weighted Average Cost of Capital for Limp Linguini