Q1 A firm has total assets worth $49, 000. lt has borrowed $10, 000 at 8.0%. If its WACC (without tax) is 16.0%, what is the firm's cost of (levered) equity capital? The firm's cost of equity capital is places. ???%. (Round to 2 decimal)
Question
Q1 A firm has total assets worth 10, 000 at 8.0%. If its WACC (without tax) is 16.0%, what is the firm's cost of (levered) equity capital? The firm's cost of equity capital is places. ???%. (Round to 2 decimal)
Solution
The firm's cost of equity capital can be calculated using the formula for the weighted average cost of capital (WACC):
WACC = wD * Cost of Debt + wE * Cost of Equity
where: wD = weight of debt = Debt / Total Assets wE = weight of equity = Equity / Total Assets Cost of Debt = 8.0% WACC = 16.0%
First, we need to calculate the weights of debt and equity:
wD = Debt / Total Assets = 49,000 = 0.2041 (rounded to 4 decimal places)
Since the weights of debt and equity must add up to 1, we can calculate the weight of equity as:
wE = 1 - wD = 1 - 0.2041 = 0.7959 (rounded to 4 decimal places)
Next, we can substitute the weights and the cost of debt into the WACC formula and solve for the cost of equity:
16.0% = 0.2041 * 8.0% + 0.7959 * Cost of Equity
Rearranging the equation to solve for the cost of equity, we get:
Cost of Equity = (16.0% - 0.2041 * 8.0%) / 0.7959
Calculating the values, we find:
Cost of Equity = 18.16%
Therefore, the firm's cost of equity capital is 18.16%.
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