KOC is a publicly traded company Istanbul. The firm provides nutriture supplies for the last 35 years. At the close of 2020 the firm’s capital structure was as follows:

Bonds	2100
Common Stock	3400
Total	5500

The company plans to keep its debt structure in the future. The pre-tax cost of debt is 7 percent and 20 percent is the cost of common stock. The marginal tax rate for the firm is 34 percent.

What is KOC’s weighted average cost of capital?

Explain what weighted average cost of capital is and why we need to calculate it as a financial manager (you may want to touch on investment decisions, different types of investors and their demands, firm's goal, etc.).

What is KOC’s weighted average cost of capital (WACC)?

Answer: 14.13%

Working:

Formula for calculating WACC is as follows

WACC = Kd * Wd + Ke * We

Where,

Kd = after tax cost of debt = 4.62 %( see notes below)

Wd = Weight of Debt =38.18% (see notes below)

Ke = Cost of Equity= 20% (given in the question)

We = Weight of Equity = 61.82% (see notes below)

WACC = Kd * Wd + Ke * We

            = (4.62% * 38.18%) + (20% * 61.82%)

            = 1.764% + 12.364%

            = 14.128%

             = 14.13%

Notes:

Kd = after tax cost of debt = pretax cost of debt * (1 – Tax rate)

                                                = 7% * (1 – 34%)

                                                = 4.62%

Weight calculation

Total capital    = Value of debt (i.e. Bond) + Value of common stock

                        = 2100 +3400

                        = 5500

Value of debt = 2100 (given in the question)

Value of common stock = 3400 (given in the question)

Wd = Weight of Debt = Value of debt ÷ Total capital

                                    = 2100÷ 5500

                                    = 0.381818

                                    = 38.18%

We = Weight of Equity = Value of common stock ÷ Total capital

                                   = 3400 ÷ 5500

                                   = 0.61818

                                   = 61.82%

What weighted average cost of capital is and why we need to calculate it as a financial manager?

When business uses different source as finance, each source has different cost. WACC helps us to calculate total cost of using these funds based on the portion of each cost in the total capital. WACC weighs the cost of capital of a particular source of capital with its proportion to the total capital. Thus, weighted average cost of capital is the weighted average after tax costs of the individual components of firm’s capital structure. That is, the after tax cost of each debt and equity is calculated separately and added together to a single overall cost of capital.

Why we need to calculate it as a financial manager?

Investment decision: While investing finance manager need to calculate WACC because he needs to ensure that project will generate return in excess of the cost of different source of finance (i.e. WACC).Finance manager will invest in any project only when investment return is more than WACC.

Different type of investors and demands: each type of investors cost have different cost. WACC is the single overall cost of using these funds from different investor, Since we calculate WACC finance manager need not worry about cost of each investor he need to see that his investment return is more than WACC.

Firms goal: Firms goal is to maximize the value of business, value maximization happens when business generate return more than cost of capital, when firm has different source of capital WACC helps the manager to find the total cost of these different source capital. Which will helps manager to generate return more than WACC and which will lead to value maximization of the business?