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Question:
ABC Company currently has a debt‐to‐equity ratio of 0.3. Its target debt‐to‐equity ratio is 0.4. The risk‐free rate is 6%, and expected equity market return is 12%. ABC is considering a project that has a beta of 1.2. Given that the company’s after‐tax cost of debt is 7%, and the applicable tax rate is 40%, the WACC that should be used in evaluating this project is closest to:
A
11.43%.
explanation
Cost of equity = 0.06 + 1.2 (0.12 − 0.06) = 13.2%
Using component weights in the target capital structure:
WACC = [0.132 x (1/1.4)] + [0.07 x (0.4 /1.4)] = 11.43%
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