Gangland Water Guns, Inc. has a debt-to-equity ratio of 0.5. If the firm's cost of debt is 7%, its cost of equity is 13% and it pays no tax, what is its WACC?

Question

Quizplus · Accepted Answer

We can use the WACC formula to solve for Gangland Water Guns' WACC:
WACC = (E/V) × Re + (D/V) × Rd × (1 - T)
where:
E = market value of equity
D = market value of debt
V = E + D
Re = cost of equity
Rd = cost of debt
T = tax rate (0 in this case)

We don't have the market values of debt and equity, but we know the debt-to-equity ratio is 0.5, so we can assume that D = 0.5E.

Plugging in the given values:
WACC = (E/(E + 0.5E)) × 0.13 + (0.5E/(E + 0.5E)) × 0.07 × (1 - 0)
Simplifying:
WACC = 0.11 or 11%

Therefore, the best choice is C) 11%.