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Ru = 17.6%
Example
Ru 17.60%
RL ?
Debt 60%
Equity 40%
Interest Rate 16%
RL =17.6%+60%/40%*(17.6%-16%)
RL = 20%
Formula
WACC = RL * E/(D+E) + Rd * D/(D+E) WACC =
WACC = 20% * 40% + 16% *60%
WACC = 17.6%
Capital Structure
Case Debt Equity Rd (Interest) Ru RL WACC
1 0% 100% 17.60% 17.60%
2 10% 90% 16% 17.78% 17.600%
3 20% 80% 16% 18.00% 17.600%
4 30% 70% 16% 18.29% 17.600%
5 40% 60% 16% 18.67% 17.600%
6 50% 50% 16% 19.20% 17.600%
7 60% 40% 16% 20.00% 17.600%
8 70% 30% 16% 21.33% 17.600%
9 75% 25% 16% 22.40% 17.600%
10 90% 10% 16% 32.00% 17.600%
11 95% 5% 16% 48.00% 17.600%
Rd RL WACC 60%
16% 17.78% 17.60% 50%
16% 18.00% 17.60%
40%
16% 18.29% 17.60%
16% 18.67% 17.60% 30%
16% 19.20% 17.60% 20%
16% 20.00% 17.60% 10%
16% 21.33% 17.60%
0%
16% 22.40% 17.60% 1 2 3 4 5 6 7 8 9
16% 32.00% 17.60%
16% 48.00% 17.60%
This graph shows that WACC is constant even when we change capital structure (Debt level). If WACC is constant then i
the same hence commpany's profitability remains the same. Therefore, it doesn't matter if a company takes a lot of deb
debt, proving MM theory.
Wtd. Avg
8.00%
9.60%
17.60%
Notes
All equity firm, no debt
Formula in column F:
RL = Ru+ D/E *(Ru-Rd)
Formula in column G:
WACC = RL*E/(D+E) +
Rd*D/(D+E)
Formula in column F:
RL = Ru+ D/E *(Ru-Rd)
Formula in column G:
WACC = RL*E/(D+E) +
Rd*D/(D+E)
Rd
RL
WACC
5 6 7 8 9 10
Reverse Example
Ru 17.88%
RL ?
Debt 60%
Equity 40%
Interest Rate 16%
Tax 25%
RL = Ru + D/E * (Ru - Rd)* (1 - T)
RL = 20.00%
Formula
WACC = RL * E/(D+E) + Rd * D/(D+E)*(1-T)
WACC = 15.20%
This graph shows that WACC changes when we change capital structure (Debt level).
quity + Cost of Debt * Wt of Debt * (1-T)
Notes
All equity firm, no debt
Formula in column F:
RL = Ru+ D/E *(Ru-Rd)*(1-T)
Formula in column G:
WACC = RL*E/(D+E) +
Rd*D/(D+E)*(1-T)
Rd
RL
WACC
4 5 6 7 8 9 10
Re = Rf + Bi (Rm – Rf)
Share price = 90, Government bond rate = 12%,
Share price fluctuates twice as average market, 100
Tax rate = 20%
Cost of Equity = 12% + 2(14.5%-12%) = 17%
rate = 12%,
age market, 100 index return = 14.5%
%) = 17%