Suppose Simmons' common stock has a beta of 1.37,the risk-free rate is 3.4 percent,and the market risk premium is 8.2 percent.The yield to maturity on the firm's bonds is 7.6 percent and the debt-equity ratio is .45.What is the WACC if the tax rate is 23 percent and all interest is tax deductible?
A)14.07 percent
B)10.94 percent
C)12.60 percent
D)10.59 percent
E)11.91 percent

Question

Quizplus · Accepted Answer

First, calculate the cost of equity using the CAPM formula: Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium = 3.4% + 1.37 * 8.2% = 3.4% + 11.23% = 14.63%.Next, calculate the after-tax cost of debt: After-Tax Cost of Debt = Yield to Maturity * (1 - Tax Rate) = 7.6% * (1 - 0.23) = 7.6% * 0.77 = 5.85%.Then, calculate the weights of equity and debt in the capital structure. Let E be the market value of equity and D be the market value of debt. The debt-equity ratio is D/E = 0.45, which implies D = 0.45E. The total value of the firm, V, is E + D = E + 0.45E = 1.45E. Therefore, the weight of equity, W_E, is E / (E + D) = E / 1.45E = 1 / 1.45, and the weight of debt, W_D, is D / (E + D) = 0.45E / 1.45E = 0.45 / 1.45.Finally, calculate the WACC: WACC = W_E * Cost of Equity + W_D * After-Tax Cost of Debt = (1 / 1.45) * 14.63% + (0.45 / 1.45) * 5.85% ≈ 11.91%.

Suppose Simmons' Common Stock Has a Beta of 1