Banana Electric is a public company with the following details: Risk free rate 2.0% MRP 5.0% Observed Beta 1.0 Price per share $10.00 Shares outstanding 1,000.0 Debt (market value) 200.0 Cash 1,500.0 Cost of debt 2.0% Tax rate 0.0% Question: Calculate the weighted average cost of capital.

6.90 %

Explanation:

The weighted average cost of capital (WACC) is the cost of the sources of finance pooled together.

WACC = Cost of equity x Weight of Equity + Cost of Debt x Weight of Debt

where,

Cost of equity = Return from risk free security + Beta x Market Premium

                        = 2.0% + 1.0 x 5.0%

                        = 7.0 %

After tax cost of debt = Interest x ( 1 - tax rate)

                                    = 2.0%

Weight of Equity = $10,000 / ($200.0 + $10,000) = 98 %

Weight of Debt = $200.0 / ($200.0 + $10,000) = 1.96 %

therefore,

WACC =  7.0 % x 0.98 + 2.0% x 0.02

           = 6.90 %

thus,

The weighted average cost of capital is 6.90 %.

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