Answer to Question #266431 in Marketing for Vishal

Question

LT India Ltd has the following capital structure, which it considers optimal:

Debt 35%

Equity shares 65%

Total 100%

Applicable tax rate for the company is 25%. Risk free rate of return is 6%, average equity market investment has expected rate of return of 12%. The company’s beta is 1.10. Debt will bear an interest rate of 9% p.a.

Calculate

a. component cost of debt and equity shares assuming that the company does not issue any additional equity shares. (5 Marks)

b. Weighted Average Cost of Capital (WACC).(5 Marks)

Answer 1

(a)

Equity

Expected Return = 6% + 1.1 (12%-6%)

=12.6%

Debt

Cost of debt = 9% (1-0.25)

= 6.75%

 

(b)

WACC = (0.35X6.75%) + (0.65X12.6%)

= 10.55%

References

Farber, A., Gillet, R.L. and Szafarz, A., 2006. A General Formula for the WACC. International Journal of Business, 11(2).