Sirtex Medical 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

The 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 the equity, D is the market value of the debt, V is the total value (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Here, E = $4 million, D = $12 million, V = $4 million + $12 million = $16 million, Rd = 5%, Tc = 30%, and Re can be calculated using the Capital Asset Pricing Model (CAPM) formula: Re = risk-free rate + (beta * market risk premium) = 4% + (1 * 7%) = 11%. Plugging these values into the WACC formula gives: WACC = ($4 million / $16 million) * 11% + ($12 million / $16 million) * 5% * (1 - 0.30) = 0.25 * 11% + 0.75 * 5% * 0.7 = 2.75% + 2.625% = 5.375%, which rounds to 5.38%.

Sirtex Medical Has $4 Million of Outstanding Equity and $12