I think the correct answer is 11%. The question states Debt to Equity ratio as 0.5. That is D divided by E=0.5 which obviously means E has a greater value than D. Let's put 1 for D and 2 for E. So 1 divided by 2 = 0.5
Total capital = debt+equity, which is 3 as per our assumption
now allocate the weight to each capital component
debt=1/3= 33.33%
equity 2/3 = 66.67%
Wacc for debt = 33.33%x 7%= 2.33%
wacc for equity = 66.67% x 13%= 8.67%
total wacc= 2.33%+8.67%= 11%
I think this make sense. Debt to equity ratio of 0.5 doesn't mean both are equally distributed. The ratio should be 1 in order for both of them to have equal representation in the capital structure.
sorry for the wrong answer and explanation initially.
thank you.
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Sunil Divakaran
Accountant
DUBAI
United Arab Emirates
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Original Message:
Sent: 11-23-2019 02:40 AM
From: Sunil Divakaran
Subject: cost of capital-WACC
10%
WACC=weight x after tax cost of capital of each capital component
here debt to equity ratio is 50%. So both debt and equity are 50% each.
applying this to the formula:
WACC for debt= .50x.07= 0.035
WACC for equity= .50x.13= 0.065
Total WACC= 0.035+0.065= 0.10 or 10%#
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Sunil Divakaran
Accountant
DUBAI
United Arab Emirates
Original Message:
Sent: 11-22-2019 03:13 AM
From: Syed Yousuf Jamal
Subject: cost of capital-WACC
Gangland Water Guns Inc. has a debt-to-equity ratio of 0.5. If the firm's after-tax cost of debt is 7% and its cost of equity is 13%, what is the appropriate WACC?
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Syed Yousuf Jamal
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