A public corporation in which you own common stock reported a WACC of 10.7% for the year in its annual report to stockholders. The common stock that you own has averaged a total return of 6% per year over the last 3 years. The annual report also mentions that projects within the corporation are 80% funded by its own capital. Estimate the company’s cost of debt capital. Does this seem like a reasonable rate for borrowed funds?
What will be an ideal response?
Solve for X, the cost of debt capital
WACC = 10.7% = 0.8(6%) + (1-0.8)(X)
X = (10.7 – 4.8)/0.2
= 29.5%
The rate of 29.5% for debt capital (loans, bonds, etc.) seems very high.
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