# WACC Calculation

P1. Longhorn Corporation is a startup company that wishes to calculate its weighted average cost of capital. You have been hired to perform this work, and the CFO has provided the following facts relative to it:

Debt Ratio Equity Ratio Debt Yield (a-tax) Cost of Equity

20% 80% 6.00% 8.50%

40% 60% 7.00% 9.00%

50% 50% 7.50% 11.00%

60% 40% 8.50% 12.00%

80% 20% 10.00% 14.00%

The CFO mentions to you that a debt ratio above 65% could cause more frequent reviews by the credit ratings agencies. The company does not issue preferred stock, and it intends to implement a payout ratio of 0% for at least the next three years. She is asking you to complete the following table so that she can evaluate all options:

Debt Ratio Equity Ratio WACC

20% 80% ?

25% 75%

30% 70%

35% 65%

40% 60%

45% 55%

50% 50%

55% 45%

60% 40%

65% 35%

70% 30%

75% 25%

80% 20%

What capital structure would you recommend (hint: determine the optimal capital structure)? Why?

https://brainmass.com/business/financial-ratios/debt-ratio-equity-ratio-debt-yield-tax-cost-equity-94951

#### Solution Preview

P1. Longhorn Corporation is a startup company that wishes to calculate its weighted average cost of capital. You have been hired to perform this work, and the CFO has provided the following facts relative to it:

Debt Ratio Equity Ratio Debt Yield (after-tax) Cost of Equity

20% 80% 6.00% 8.50%

40% 60% 7.00% 9.00%

50% 50% 7.50% 11.00%

60% 40% 8.50% 12.00%

80% 20% 10.00% 14.00%

The CFO mentions to you that a debt ratio above 65% could cause more frequent reviews by the credit ratings agencies. The company does not issue preferred stock, and it intends to implement a payout ratio of 0% for at least the next three years. She is asking you to complete the following table so that she can evaluate all options:

Debt Ratio Equity Ratio WACC

20% 80% 8.00%

25% 75%

30% 70%

35% 65%

40% 60% 8.20%

45% ...

#### Solution Summary

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