Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

Question

Quizplus · Accepted Answer

Weighted Average Cost of Capital (WACC) = E/(E+D)*Re + D/(E+D)*Rd*(1-Tc)
where,
E = Equity
D = Debt
Re = Cost of equity
Rd = Cost of debt
Tc = Tax rate

Given,
Debt-equity ratio = D/E = 0.62
Tax rate (Tc) = 21%
Cost of equity (Re) = 16.3%
After-tax cost of debt (Rd) = 5.21%

Let us assume that the total value of the firm is $100. Then,
Equity (E) = $100/(1+0.62) = $61.73
Debt (D) = $100 - $61.73 = $38.27

Substituting the given values in the formula, we get:
WACC = (61.73/100)*16.3% + (38.27/100)*5.21%*(1-21%)
= 12.06%

Therefore, the answer is C.

Kelso's Has a Debt-Equity Ratio of