Use the following information answer the three questions below. A firm has an opportunity cost of capital of 15%, it can borrow long term debt at a cost of 10%, it is marginal tax rat is 50% and it has an expected cash flow to the firm of 150 (in perpetuity).The market value of it is equity and debt are 900 and 600 , respectively .1 What is the firm WACC?
WACC stands for Weighted Average Cost of Capital and is a calculation used to measure the average rate of return a company needs to earn on its investments in order to satisfy its shareholders, investors, and creditors.
To calculate the WACC, we need to weigh the cost of equity and the cost of debt based on their respective proportions in the firm's capital structure. The formula for WACC is as follows:
WACC = (E/V) * Ke + (D/V) * Kd * (1 - Tax rate)
Where:
E = Market value of equity
V = Total market value of debt and equity
Ke = Cost of equity
D = Market value of debt
Kd = Cost of debt
Tax rate = Marginal tax rate
Given the provided information:
E = 900
V = E + D = 900 + 600 = 1500
Ke = Opportunity cost of capital = 15%
D = 600
Kd = Cost of debt = 10%
Tax rate = 50%
Now we can substitute the values into the WACC formula:
WACC = (E/V) * Ke + (D/V) * Kd * (1 - Tax rate)
= (900/1500) * 15% + (600/1500) * 10% * (1 - 50%)
= 0.6 * 0.15 + 0.4 * 0.10 * (1 - 0.50)
= 0.09 + 0.04 * 0.50
= 0.09 + 0.02
= 0.11 or 11%
Therefore, the firm's WACC is 11%.