A firm has an opportunity cost equal equal of 15% , it can borrow long term debt at a cost of 10%, is marginal tax rat is 50% and it has an expected cash flow to the firm of 150 (in perpetuity). The market value what is the firm WACC?
To calculate the Weighted Average Cost of Capital (WACC), we need to determine the proportions of debt and equity in the firm's capital structure and the respective costs of each.
Let's assume the firm's capital structure consists of 80% equity and 20% debt. Accordingly, the weights are as follows:
Equity Weight: 80% = 0.8
Debt Weight: 20% = 0.2
The cost of equity is given by the opportunity cost, which is equal to 15%.
Cost of Equity: 15% = 0.15
The cost of debt is determined by the actual borrowing cost of 10%, adjusted for the tax benefit provided by the marginal tax rate of 50%. The after-tax cost of debt can be calculated as:
After-Tax Cost of Debt = Cost of Debt * (1 - Marginal Tax Rate)
After-Tax Cost of Debt = 10% * (1 - 50%)
After-Tax Cost of Debt = 0.10 * 0.50 = 0.05 = 5%
Now, we can calculate the WACC using the formula:
WACC = (Equity Weight * Cost of Equity) + (Debt Weight * After-Tax Cost of Debt)
WACC = (0.8 * 0.15) + (0.2 * 0.05)
WACC = 0.12 + 0.01
WACC = 0.13 = 13%
Therefore, the firm's WACC is 13%.