McLarenF1 is expected to have a weighted-average cost of capital equal to 10.2%. The company has a debt-to-equity ratio equal to 1.5. McLarenF1's after-tax cost of debt is equal to 4.9%. What is the cost of equity (re) equal to: Do not enter the % sign in your answer.If you solve this problem with algebra, round any intermediate calculations to 6 decimal places.Write your answer as a whole number, not a decimal. In all cases round your final answer to two decimal places, e.g. 8.723456% (0.082734), write 8.72
Question
McLarenF1 is expected to have a weighted-average cost of capital equal to 10.2%. The company has a debt-to-equity ratio equal to 1.5. McLarenF1's after-tax cost of debt is equal to 4.9%. What is the cost of equity (re) equal to: Do not enter the % sign in your answer.If you solve this problem with algebra, round any intermediate calculations to 6 decimal places.Write your answer as a whole number, not a decimal. In all cases round your final answer to two decimal places, e.g. 8.723456% (0.082734), write 8.72
Solution
The weighted-average cost of capital (WACC) is calculated as follows:
WACC = re * (E/V) + rd * (D/V) * (1 - Tc)
Where: re = cost of equity rd = cost of debt E = market value of equity D = market value of debt V = total market value of equity and debt Tc = corporate tax rate
Given that the company has a debt-to-equity ratio of 1.5, the proportion of debt (D/V) is 1.5 / (1 + 1.5) = 0.6 and the proportion of equity (E/V) is 1 / (1 + 1.5) = 0.4.
The after-tax cost of debt is given as 4.9%.
Substituting these values into the WACC formula, we get:
10.2% = re * 0.4 + 4.9% * 0.6
Solving for re, we get:
re = (10.2% - 4.9% * 0.6) / 0.4 re = 13.95%
So, the cost of equity (re) is approximately 13.95%.
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