Can someone please explain how cost of debt, cost of equity, and WACC relate to
ID: 2660630 • Letter: C
Question
Can someone please explain how cost of debt, cost of equity, and WACC relate to each other? This chapter has been totally over my head.
Also how would the following scenarios affect a frim's cost of debt, cost of equity and WACC? Indicate with + - or 0
a. corporate tax rate is lowered
c. firm uses more debt it increases its debt/assets ratio
e. frim doubles the amount of capital it raises during the year
g. firm merges with another firm whose earnings are countercyclical both to those of the first firm and to the stock market
h. stock market falls drastically, adn the firm's stock price falls along with the rest
j. the firm is an electric utility with a large investment in nuclear plants. several states are considering a ban on nuclear power generation.
Explanation / Answer
WACC = w1*cost of debt*(1-T) + w2*cost of equity
where w1 = debt/(debt+equity)
w2 = equity/(debt+equity)
T = tax rate
WACC is weighted average cost of capital as the name suggest it is the weighted average cost fo capital, we can't simply average it out, we have to weighted average them