wacc weights

CFA Level I
#1

Hey Guys,

Could you please help me with this exercise?

A firm with a marginal tax rate of 40% has a weighted average cost of capital of 7.11%. The before-tax cost of debt is 6%, and the cost of equity is 9%. The weight of equity in the firm’s capital structure is closest to:

37%.

79%.

65%.

#2

WACC = (1-W)*Kd(1-t) + W*Ke

Substitute and solve for W.

#3

Let:

we=weight of equity capital 1-we=weight of debt capital rd=before tax cost of debt re=cost of equity

sovle the equation:

wacc=(1-we)(1-t)rd + we(re)

You will get 65.00%

#4

It’s less work simply to try the middle value: 65% equity. If that gives you 7.11% WACC, you’re done: 65% is the correct answer.

If you get something higher than 7.11% WACC, you’re done: 37% is the correct answer.

If you get something lower than 7.11% WACC, you’re done: 79% is the correct answer.

Part of the skill in passing this test is learning to pass the test, rather than spending time solving general problems.

#5

I don’t agree completely, because the CFA program does not intend to teach you how to solve multiple choice problems efficiently, it would be best if candidates know the real solution behind the problem instead of plugging away numbers.

In some other cases, I can see problem solving skills becoming a benefit if the candidate can shortcut steps to get the final answer, but does not use the choices to tip him off. That won’t be helpful in a real life situation.

1 Like
#6

But we’re not talking about a real life situation here; we’re talking about passing a test.

#7

How do you expect him to pass the test if he solves problems using elimination algebra.

#8

I explained how here:

He does one simple calculation and from that gets the correct answer. Getting correct answers is the key to passing the test.

#9

This is embarrassing but could you guys help me work on the algebra to solve for w? don’t know why I cant get the right answer. Thanks in advance

#10

I get your point and I would like to ask you where did you learn these kind of tricks? is there any website that shows them ? thanks in advance

#11

wacc = (1-we)(1-t)(rd) + (we)(re)

wacc = (1-t)(rd) - (we)(1-t)(rd) +(we)(re)

wacc = (1-t)rd +(we)[(re) - (1-t)(rd)]

wacc - (1-t)(rd) = (we)[(re) - (1-t)(rd)]

we = [wacc - (1-t)(rd)] / [(re) - (1-t)(rd)]

#12

thanks a lot!