Company XYZ is funded with $500 million equity and $475 million debt. The yield on bonds issued by XYZ is 7.85%. Its beta is 1.15 and the tax rate is 40%. The risk-free rate is 5% with the market risk premium 9%. The weighted average cost of capital for this firm is:

the weighted cost of capital is 10.16%

Explanation:

The computation of the weighted average cost of capital is as follows

The WACC is

= Cost of debt × weight of debt × (1 - tax rate) + weight of equity × cost of equity

where,

Weight of debt is

= $475 ÷ ($475 + $500)

= 0.487

Weight of equity is

= $500 ÷ ($475 + $500)

= 0.513

Cost of equity is

= Risk free rate + beta × market risk premium

= 5% + 1.15 × 9%

= 15.35%

Now the WACC is

= 7.85% × 0.487 × (1 - 0.40) + 0.513 × 15.35%

= 2.29% + 7.87%

= 10.16%

hence, the weighted cost of capital is 10.16%

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