Calculate the WACC for a firm with a debtequity ratio of 15

Calculate the WACC for a firm with a debt-equity ratio of 1.5. The debt pays 10 percent interest and the equity is expected to return 16 percent. Assume a 35 percent tax rate and risk-free debt.

Solution

After tax cost of debt=10*(1-tax rate)

=10(1-0.35)=6.5%

Debt-equity ratio=Debt/equity

Hence debt=1.5equity

Let equity be $x

Hence debt=$1.5x

Total=$2.5x

WACC=Respective costs*Respective weights

=(x/2.5x*16)+(1.5x/2.5x*6.5)

which is equal to

=10.3%