A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the pre-tax WACC?

Question

Quizplus · Accepted Answer

The pre-tax Weighted Average Cost of Capital (WACC) is calculated by taking the weighted average of the cost of equity and the cost of debt. Since there is no specific cost of equity given, we can calculate the overall return required from the investment, which is ($25,000 - $20,000) / $20,000 = 25%. Given that the debt portion is financed at 7%, and assuming the cost of equity equals the overall return required (since it's not specified), the WACC is the average of these two, weighted by their respective proportions in the financing mix (50% equity at 25% and 50% debt at 7%). Thus, WACC = (0.5 * 25%) + (0.5 * 7%) = 12.5% + 3.5% = 16%. However, none of the provided options match this calculation directly, suggesting a misunderstanding in the calculation process or a misinterpretation of the question's requirements. Given the options, the closest to a logical answer based on the information provided would be to consider the overall return of 25% as the answer, assuming the question intended to ask for the return on the investment rather than the traditional calculation of WACC.

A New Business Requires a $20,000 Investment Today,and Will Generate