ABC Inc. borrows money at 9%, sells bonds at 8%, and the purchasers of common stock require 13% rate of return. If the company has borrowed $40 million, sold $60 million in bonds, and sold $100 million worth of common stocks, what is the Weighted Average Cost of Capital (WACC)? If the same company from the previous question used 5% ROR for loans, 9% ROR for bonds, and 12% ROR for stocks, and also used a 50% tax rate, what is the WACC?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
ABC Inc. borrows money at 9%, sells bonds at 8%, and the purchasers of common stock require 13%
If the same company from the previous question used 5% ROR for loans, 9% ROR for bonds, and 12% ROR for stocks, and also used a 50% tax rate, what is the WACC?
Step by step
Solved in 4 steps
