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17 March, 14:22

A venture has raised $4,000 of debt and $6,000 of equity to finance its firm. Its cost of borrowing is 6%, its tax rate is 40%, and its cost of equity capital is 8%. What is the venture's weighted average cost of capital?

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  1. 17 March, 17:01
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    WACC = 6.24%≈ 6.2%

    Explanation:

    Weighted average cost of capital (WACC) = { (S/T) * r1} + { (D/T) * r2) * (1-R) }

    Let us define the terms

    Stockholder Equity (S) = $6,000

    Total value of business = S+D = 4,000+6,000 = 10,000

    Cost of equity (r1) = 8%

    Debt (D) = $4,000

    Cost of debt) r2) = 6%

    Tax rate (R) = 40%

    Therefore

    WACC = { (6,000/10,000) * 0.08} + { (4,000/10,000) * 0.06 * (1-0.40) }

    WACC = 0.048 + (0.024*0.6) = 0.048+0.0144

    WACC = 0.0624

    WACC = 6.24%
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