Desires to maintain a capital structure of 80% equity and 20% debt. They currently have an effective tax rate of 30%. The company's cost of equity capital is 12%. To obtain their debt financing, they issue bonds with an interest rate of 10%. What is the company's weighted average cost of capital?

a. 8%

b. 10.4%

c. 11%

d. 11.6%

The correct is option C, 11%

Explanation:

WACC=Ke*E/V+Kd*D/V * (1-t)

Ke is the cost of equity at 12%

E/V=Equity/Equity+Debt

Equity is 80% that is 0.8

Debt is 20% that is 0.2

V=equity+debt=0.8+0.2=1

Kd is the cost of debt at 10%

t is the tax rate at 30% that is 0.3

WACC=12%*0.8/1+10%*0.2/1 * (1-0.3)

=12%*0.8/1+10%*0.2/1*0.7

=12%*0.8+10%*0.2*0.7

=12%*0.8+10%*0.14

=9.6%+1.4%

=11%

The weighted average cost of capital for the company is 11%

c. 11%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs. weightage can be calculated by using the market value of the equity and debt.

The formula for WACC is

Weighted average cost of capital = (Cost of equity x Weightage of equity) + (Cost of debt (1 - tax) x Weightage of debt)

Weighted average cost of capital = (12% x 80%) + (10% (1-0.3) x 20%)

Weighted average cost of capital = 9.6% + 1.4% = 11%