This workout asks us to calculate the company's average cost of capital Now we might notice as we go down, we've got information like the 10 year government bonds Estimated equity risk premium. I'm expecting to have to do some kind of CAPM to get to my cost of equity I also notice, they've got an existing cost of debt and cost of debt with the target capital structure We're always going to be looking at the cost of debt with the target capital structure We've then got the percentage of equity and debt with the existing capital And the percentage of equity and debt in the target capital structure Okay, so we have to start by calculating the unlevered beta. That suggests the beta of 1.7 provided is levered That's levered with the existing capital structure, it's got the wrong level of debt in it (that 1.7) So we need to take the debt out, so we start off by taking that 1.7 and we then divide it by one plus open brackets One minus the tax rate, times by the existing level of debt divided by the existing level of equity That will now strip out the level of debt And the beta goes down, it wasn't 1.7 when it had lot's of debt, it's now come down 0.8 Less debt, less risk, lower beta But I now need to reliver the beta, I now need to put in the correct level of debt So I take the 0.8 and I now multiply it by one plus open brackets, one minus the tax rate All multiplied by the percentage debt in the target capital structure, divided by equity in the target capital structure So I'm now putting debt back in, I should expect to see that beta go up. And it does, it goes up to 1.2 Fantastic! Let's now finish up the cost of equity, I need to start off with my risk free return That's the 10 year government bond and I'm going to add onto that the estimated equity risk premium But I now need to multiply that by my beta of 1.2 Great! My cost of equity in the target capital structure is 10.5% We now need a cost of debt after tax in the target capital structure Two figures available to us, the existing cost of debt and the cost of debt with the target capital structure (I want to go with that one) That's your 5%! But remember, we need to make it post tax So multiply it by one minus the tax rate, gives me a figure of 3.8% I now need to bring it altogether in my WACC, so that means I will take my cost of equity I'll multiply that by the percentage of equity in the target capital structure I'll then add onto that my cost of debt, which is already post tax Multiplied by the percentage debt in target capital structure That then gives me a WACC of 7.7%