Answer to Question #129584 in Financial Math for Nahashon Kimathi

Question

Company ABC has the following capital structure:
Sh
Ordinary share capital 300000
Retained earnings 150000
8% preference share capital 100000
10% debt finance 50000
Total Capital employed 600000
This company has been paying ordinary dividend of 10% per annum and expects equity to grow
at 6% per annum. Tax = 50%
Calculate the weighted Average Cost of Capital for this com�pany

Answer 1

we know the formula of weighted average cost of capital ( WACC ):

WACC = ($\frac{E}{V}$ x R_e ) + [ ($\frac{D}{V}$ X R_d ) (1-T_c) ]

Where :

E=Market value of the firm’s equity=300000+150000=450000

D=Market value of the firm’s debt=100000+50000=150000

V=E+D=-450000+150000=600000 = total capital employed

R_e=Cost of equity = 6%

R_d=Cost of debt = 10%

T_c=Corporate tax rate = 50%

WACC = ($\frac{450000}{600000}$ x $\frac{6}{100}$ ) + [ ($\frac{150000}{600000}$ x $\frac{10}{100}$ ) (1 - $\frac{50}{100}$ ) ]

= ($\frac{45}{60}$ x $\frac{6}{100}$ ) + [ ($\frac{15}{60}$ x $\frac{1}{10}$ )( 1 - $\frac{1}{2}$ )

= ( 0.045) + [ (0.025)(0.5)]

= (0.045) + (0.0125)

= 0.0575

WACC = 5.75%

5.75% is  the weighted Average Cost of Capital for this company.