Answer:
Option (a) 12.23%
Explanation:
Data provided in the question:
Debt-equity ratio = 0.6
or
Debt = 0.6 × Equity
Cost of equity, ke = 16% = 0.16
Pretax cost of debt, kd = 9% = 0.09
Tax rate = 34% = 0.34
Now,
Firm's WACC = [ weight of equity × ke] + [ Weight of debt × kd × (1-Tax rate) ]
also,
weight of equity = Equity ÷ ( Debt + equity )
= Equity ÷ ( 0.6 × Equity + equity )
= 1 ÷ 1.6
= 0.625
weight of Debt = Debt ÷ ( Debt + equity )
= 0.6 × Equity ÷ ( 0.6 × Equity + equity )
= 0.6 ÷ 1.6
= 0.375
Thus,
Firm's WACC = [ 0.625 × 0.16 ] + [ 0.375 × 0.09 × (1- 0.34) ]
= 0.1 + 0.022275
= 0.122275
or
= 0.122275 × 100%
= 12.2275% ≈ 12.23%
