A firm is currently financed with $300 of debt and $700 of equity. The expected return on the debt is 9%. The market beta of the firm's equity is 1.50; the risk-free rate is 4%; and the equity premium is 6%. The firm pays taxes at the marginal rate of 35%.
-Refer to the information above. What is the firm's WACC? Round your answer to the nearest tenth of a 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 equity, D is the market value of debt, V is the total value of financing (E + D), Re is the cost of equity, 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 + β(E[Rm] - Rf), where Rf is the risk-free rate, β is the beta of the firm's equity, and E[Rm] - Rf is the equity premium.Given:- E = $700- D = $300- V = E + D = $700 + $300 = $1000- Rd = 9%- β = 1.50- Rf = 4%- Equity premium = 6%- Tc = 35%First, calculate Re using CAPM:Re = Rf + β(E[Rm] - Rf) = 4% + 1.50(6%) = 4% + 9% = 13%Then, calculate WACC:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) = ($700/$1000) * 13% + ($300/$1000) * 9% * (1 - 0.35) = 0.7 * 13% + 0.3 * 9% * 0.65 ≈ 9.1% + 1.755% ≈ 10.855%Since 10.855% is not an option and does not round to any of the given choices, the correct answer is D) none of the above.

A Firm Is Currently Financed with $300 of Debt and $700