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You would like to estimate the weighted average cost of capital for a new airline business. Based on its industry asset beta, you have already estimated an unlevered cost of capital for the firm of 9%. However, the new business will be 25% debt financed, and you anticipate its debt cost of capital will be 6%. If its corporate tax rate is 40%, what is your estimate of its WACC?

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beritop1089

Answer:

7.65%

Explanation:

WACC = wE*rE + wD*rd(1-tax)

wE= weight of equity = (100% - 25%) = 75%

rE = cost of equity = 9% or 0.09

wD = weight of debt = 25% or 0.25

rd = pretax cost of debt = 6% or 0.06

tax = 40%

WACC = (0.75 *0.09) + [0.25 *0.06(1-0.40) ]

WACC = 0.0675 + 0.009

WACC = 0.0765 or 7.65%

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