### Firm’s Weighted Average Cost of Capital with Debt & Equity

**Question:**

A firm has 80 bonds outstanding that are selling at their par value of Rs. 1,000 each. Bonds with similar characteristics are yielding a pretax 8.6 percent. The firm also has 4,000 shares of equity stock outstanding. The stock has a beta of 1.1 and sells for Rs. 40 a share. The RBI 10-year T-bill is yielding 4 percent, the market risk premium is 8 percent, and the firm’s tax rate is 21 percent.

What is the firm’s weighted average cost of capital, assuming its earnings are sufficient to classify all interest as a tax-deductible expense?

**Steps to Calculate WACC:**

**Calculate the Cost of Debt (Kd):****Formula:**$K_{d}=Pretax Yield×(1−Tax Rate)$**Given:**Pretax Yield = 8.6%, Tax Rate = 21%**Calculation:**$K_{d}=8.6%×(1−0.21)=8.6%×0.79=6.8%$

**Calculate the Cost of Equity (Ke):****Formula:**$K_{e}=R_{f}+β×Market Risk Premium$**Given:**Risk-Free Rate (R_f) = 4%, Beta (β) = 1.1, Market Risk Premium = 8%**Calculation:**$K_{e}=4%+1.1×8%=4%+8.8%=12.8%$

**Calculate the Market Value of Debt and Equity:****Debt Market Value:**$Debt=80bonds×Rs.1,000=Rs.80,000$**Equity Market Value:**$Equity=4,000shares×Rs.40=Rs.160,000$

**Calculate the Total Market Value:****Total Market Value:**$Total Value=Debt+Equity=Rs.80,000+Rs.160,000=Rs.240,000$

**Calculate the Weights for Debt and Equity:****Weight of Debt (W_d):**$W_{d}=Total ValueDebt =Rs,Rs, =31 ≈0.333$**Weight of Equity (W_e):**$W_{e}=Total ValueEquity =Rs,Rs, =32 ≈0.667$

**Calculate the Weighted Average Cost of Capital (WACC):****Formula:**$WACC=(W_{d}×K_{d})+(W_{e}×K_{e})$**Calculation:**$WACC=(0.333×6.8%)+(0.667×12.8%)$ $WACC=2.27%+8.54%=10.81%$

**Answer:**

The firm’s Weighted Average Cost of Capital (WACC) is **10.81%**.

**Description:**

To calculate a firm’s WACC, consider the cost of debt and equity, market values, and relevant tax rates. For this firm, the WACC is 10.81%, reflecting the weighted average costs of both debt and equity financing.

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