Financial Management
Estimate the cost of capital
Debt costs 8% and equity costs 12%. Why is the company’s hurdle neither one of those?
A project funded by a mix of debt and equity must earn enough to compensate both groups. WACC combines their required returns.
WACC = equity weight × cost of equity + debt weight × cost of debt × (1 − tax rate)
E and D are fractions of total market-value funding. Multiply 0.60 × 12%, then add 0.40 × 8% × (1 − 0.25). The result is 9.6%.
60% equity at 12%, 40% debt at 8% and a hypothetical 25% tax rate give 7.2% + 2.4% = 9.6%.
E and D are fractions of total market-value funding. Multiply 0.60 × 12%, then add 0.40 × 8% × (1 − 0.25). The result is 9.6%.
Keep all inputs fixed except the cost of debt, which rises from 8% to 10%. What is the new WACC?