ABC Ltd. has a gearing ratio of 40%. Its cost of equity is 21% and the cost of debt is 15%. Calculate the company's WACC
Answers
Answer :
The WACC of ABC Ltd. is 12.6%.
Explanation :
To calculate the WACC, we can use the formula:
WACC = (E/V × Ke) + (D/V × Kd) × (1 - Tc)
Where,
E = Market value of the company's equity
D = Market value of the company's debt
V = Total market value of the company (E + D)
Ke = Cost of equity
Kd = Cost of debt
Tc = Corporate tax rate
Given,
Gearing ratio = 40%
Equity proportion = 60%
Debt proportion = 40%
Ke = 21%
Kd = 15%
Tc = 0% (assumed no tax rate)
To find the market values of equity and debt, we need additional information. Assuming the market value of equity is $100 million and the market value of debt is $66.67 million (based on the given gearing ratio of 40%), we can calculate the total market value of the company:
V = E + D
V = $100 million + $66.67 million
V = $166.67 million
Now, we can substitute the values into the WACC formula:
WACC = (E/V × Ke) + (D/V × Kd) × (1 - Tc)
WACC = (0.6 × 0.21) + (0.4 × 0.15) × (1 - 0)
WACC = 0.126 or 12.6%
Therefore, the WACC of ABC Ltd. is 12.6%.
In conclusion, the WACC of ABC Ltd. is 12.6%, which represents the average cost of all the financing sources used by the company, weighted by their respective proportions in the capital structure.
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