The ACME Suction Cup company has $4,500 of debt and $10,500 of common stock equity. The total value of the company is $15,000. The company's cost of equity is 11.5 percent, the cost of debt is 5.9 percent and the relevant tax rate is 35 percent. What is ACME's debt-equity ratio and WACC?
To find ACME's debt-equity ratio, we need to calculate the ratio of its total debt to its total equity.
Debt-Equity Ratio = Total Debt / Total Equity
In this case, the total debt of ACME is $4,500 and the total equity is $10,500.
Debt-Equity Ratio = 4,500 / 10,500 = 0.4286
So ACME's debt-equity ratio is approximately 0.4286.
To find ACME's Weighted Average Cost of Capital (WACC), we need to calculate the weighted average of the cost of equity and the after-tax cost of debt.
WACC = (Equity Proportion * Cost of Equity) + (Debt Proportion * After-Tax Cost of Debt)
First, we need to determine the proportion of equity and debt in ACME's capital structure:
Equity Proportion = Total Equity / Total Value = 10,500 / 15,000 = 0.7
Debt Proportion = Total Debt / Total Value = 4,500 / 15,000 = 0.3
Next, we can calculate the after-tax cost of debt by considering the relevant tax rate:
After-Tax Cost of Debt = Cost of Debt * (1 - Tax Rate) = 5.9% * (1 - 0.35) = 3.835%
Now, we can calculate ACME's WACC:
WACC = (0.7 * 11.5%) + (0.3 * 3.835%) = 8.05%
Therefore, ACME's WACC is approximately 8.05%.