Change in Cost of CapitalImagine a company whose capital structure has ₹50 crore equity and ₹50 crore debt in Year 1. The company earned a profit of ₹30 crore at the start of Year 2 and decided to repay the debt.The company’s capital structure in Year 2 became ₹80 crore equity and ₹20 crore debt.What will be the WACC for Year 1 and Year 2 if the cost of debt is 7.5% and the cost of equity is 14%?10.75%, 10.75%10.75%, 12.70%12.70%, 12.70%
Question
Change in Cost of CapitalImagine a company whose capital structure has ₹50 crore equity and ₹50 crore debt in Year 1. The company earned a profit of ₹30 crore at the start of Year 2 and decided to repay the debt.The company’s capital structure in Year 2 became ₹80 crore equity and ₹20 crore debt.What will be the WACC for Year 1 and Year 2 if the cost of debt is 7.5% and the cost of equity is 14%?10.75%, 10.75%10.75%, 12.70%12.70%, 12.70%
Solution
The Weighted Average Cost of Capital (WACC) is calculated by multiplying the cost of each capital component by its proportional weight and then summing:
WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
Where: E = Market value of equity V = Market value of equity + Market value of debt Re = Cost of equity D = Market value of debt Rd = Cost of debt Tc = Corporate tax rate
In this case, the tax rate is not given, so we will assume it to be 0 for simplicity.
For Year 1: E = ₹50 crore D = ₹50 crore V = E + D = ₹100 crore Re = 14% Rd = 7.5%
WACC for Year 1 = (50/100)*14% + (50/100)*7.5% = 10.75%
For Year 2: E = ₹80 crore D = ₹20 crore V = E + D = ₹100 crore Re = 14% Rd = 7.5%
WACC for Year 2 = (80/100)*14% + (20/100)*7.5% = 12.7%
So, the WACC for Year 1 and Year 2 are 10.75% and 12.7% respectively.
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