Answer: 10.8%
Explanation:
To calculate the weighted average cost of capital we use the following formula,
WACC = Ve/Vt * Re + Vd/Vt * Rd( 1 - tax rate)
Where,
Ve is the value of equity in the company
Vt is the total value of the company gotten by adding debt to Equity.
Re is the cost of Equity
Vd is the total value of debt in the company
Rd is the cost of debt
From the question above we have every variable except the Cost of Equity.
We can calculate that using the CAPM formula which is,
Re = rF + b(rM - rF)
Where,
rF is the risk free rate
b is beta
rM - rF is the market premium.
Plugging in the figures we have,
= 4% + 1.1 ( 8%)
= 12.8%
Now that we have the cost of debt we can go back to the original formula but first the value of Equity and debt need to be ascertained,
Value of debt = 80,000 * $1,000 ( par value)
= $80,000,000
Value of Equity = 4,000,000 * 40
= $160,000,000
Adding them up we have,
= $160 m + $80m
= $240m
WACC = Ve/Vt * Re + Vd/Vt * Rd( 1 - tax rate)
WACC = (160/240 * 12.8%) + (80/240 * 8.5%( 1 - 0.35)
WACC = 10.8%
Jack's weighted average cost of capital is 10.8%.
