Corporate Finance

rishabhhurkat
Good Student
Posts: 24
Joined: Wed Dec 09, 2015 9:29 am

Corporate Finance

1
Marks: 1
For a Company ABC Ltd the target capital structure is 40% debt and 60% equity. The after tax cost of debt = 15%.The company unlevered stock beta is 1.4 ,with risk free rate of 8% and market risk premium of 6%.Assuming 40% marginal tax rate the WACC for the company is closest to:
a. 18.86% Incorrect
b. 19.72% Incorrect
c. 17.86% Correct

How come C is Correct Answer
None of above is Correct...

Because Beta of Equity come to 1.96
Therefore Cost of Equity shall be = 8% + 1.96*(8%-6%)

hence cost of equity = 11.92%
and cost of debt = 15%

therefore WACC = 13.15%...

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Corporate Finance

There is a calculation mistake
Now, the corrected calculations are
beta of assets=1.4
beta of equity=beta of assets *{1+(1-t)*D/E}
beta of equity=1.4{1+(1-0.4)*40/60}
=1.96
and after tax cost of debt=15%
then we will calculate WACC that is
WACC=60%{8%+1.96*6%}+40%{15%(1-40%)}
=11.86+3.6
WACC=15.46

rishabhhurkat
Good Student
Posts: 24
Joined: Wed Dec 09, 2015 9:29 am

Re: Corporate Finance

Please Correct Me if I am Wrong

Ke = Rf+ Beta(Rf-Rm)
= 8%+1.96*(8%-6%}
= 11.92%

Kd = After Tax Cost of Debt
= 15% (It is already After Tax)

WACC = (60%*11.92%) + (40%*15%)
= 13.15%

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Corporate Finance

Hi Rishabh
actually in this question market risk premium is given which is 6%, so we can not minus it from 8% which you have already did in your calculation.