Cookie Dough Manufacturing has a target debt-equity ratio of. 6. Its cost of equity is 16 percent, and its pretax cost of debt is 9%. What is the firm's WACC given a tax rate of 34%? a. 12.23% b. 12.78% c. 13.11% d. 13.48% e. 12.53%

Option (a) 12.23%

Explanation:

Data provided in the question:

Debt-equity ratio = 0.6

or

Debt = 0.6 * Equity

Cost of equity, ke = 16% = 0.16

Pretax cost of debt, kd = 9% = 0.09

Tax rate = 34% = 0.34

Now,

Firm's WACC = [ weight of equity * ke] + [ Weight of debt * kd * (1-Tax rate) ]

also,

weight of equity = Equity : (Debt + equity)

= Equity : (0.6 * Equity + equity)

= 1 : 1.6

= 0.625

weight of Debt = Debt : (Debt + equity)

= 0.6 * Equity : (0.6 * Equity + equity)

= 0.6 : 1.6

= 0.375

Thus,

Firm's WACC = [ 0.625 * 0.16 ] + [ 0.375 * 0.09 * (1 - 0.34) ]

= 0.1 + 0.022275

= 0.122275

or

= 0.122275 * 100%

= 12.2275% ≈ 12.23%