WACC=10%; 50% debt and 50% equity; cost of debt = 5%.
uestion = what’s the cost of equity? The answer states that we should use the formula of WACC on page 90. and results in 16%. However, I used the formula #9 on page 95 and the result was 14% (which was deemed incorrect). Why the results from the two fromulas don’t match? Aren’t they supposed to be the same? Page 93 seems to state that they are equivalent…
Please help me understand why I couldn’t have used the formula from page 95. Thanks so much!!
With that being said… Question #10 uses the formula from page 95 and not the formula from page 90. I thought I could use the WACC formula to solve for the cost of equity, but that doesn’t work either here…
You just need to know when to use which formula. You can utilize either one of the MM formulas when there’s no debt and/or no taxes. In this question, the firm already has debt in its structure and pays taxes. So you use the regular WACC formula, NOT one of the MM formula. If you use the MM formula with taxes, you’ll get 14%.