A firm requires an investment of $30 000 and borrows $10 000 at 6%. If the return on equity is 15% and the tax rate is 30%, what is the firm's WACC?
A)12.3%
B)11.4%
C)7.8%
D)10.1%

Question

Quizplus · Accepted Answer

First, let's calculate the cost of debt:
Cost of debt = 6% x (1 - 30%) = 4.2%

Next, let's calculate the cost of equity using the CAPM model:
Cost of equity = Risk-free rate + Beta x (Market return - Risk-free rate)
Assuming a risk-free rate of 3% and a beta of 1.5 (which is typical for a moderately risky business), we get:
Cost of equity = 3% + 1.5 x (15% - 3%) = 21%

Now, we can calculate the weighted average cost of capital (WACC) using the formula:
WACC = (Equity / Total capital) x Cost of equity + (Debt / Total capital) x Cost of debt x (1 - Tax rate)

Plugging in the numbers, we get:
WACC = (30,000 / 40,000) x 21% + (10,000 / 40,000) x 4.2% x (1 - 30%) = 11.4%

Therefore, the firm's WACC is 11.4%.

A Firm Requires an Investment of $30 000 and Borrows