SIROM Scientific Solutions has $4 million of outstanding equity and $12 million of bank debt.The bank debt costs 5% per year.The estimated equity beta is 1.If the market risk premium is 7% and the risk-free rate is 4%,compute the weighted average cost of capital if the firm's tax rate is 30%.

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the capital asset pricing model (CAPM):

CAPM = RF + β * Market Risk Premium
CAPM = 0.04 + 1 * 0.07
CAPM = 0.11 or 11%

Next, we can calculate the weighted average cost of capital (WACC):

WACC = (Equity / Total Capital) * Cost of Equity + (Debt / Total Capital) * Cost of Debt * (1 - Tax Rate)

WACC = (4M / 16M) * 0.11 + (12M / 16M) * 0.05 * (1 - 0.3)
WACC = 0.27 + 0.021
WACC = 0.291 or 5.38%

Therefore, the correct choice is C, which is 5.38%.

SIROM Scientific Solutions Has $4 Million of Outstanding Equity and $12