A. 17.2, B. 15.12 C. 12% D. 18.7%

What would be the weighted average cost of capital for Lam Bakery, Inc. under the following conditions:

*The capital structure is 40% debt and 60% equity

*The before-tax cost of debt (which includes flotation costs) is 20% and the firm is in the 40% tax bracket

*The firm's beta is 1.7

*The risk-free rate is 7% and the market risk premium is 6%

Option (B) is correct.

Explanation:

Cost of Equity (Ke) = Rf + Beta (Rp)

where,

Rf = risk free rate

Rp = Market risk premium

Hence,

Beta systematic risk:

= 7% + 1.7 (6%)

= 7% + 10.2%

= 17.2%

Post Tax cost of debt:

= Kd (1 - T)

where,

Kd = cost of debt

T = tax rate

= 20% * (1-0.4)

= 12%

WACC = [ (Ke * We) + (Wd * Kd (1-T)) ]

where,

We = weight of equity

Wd = weight of debt

= [ (17.2% * 0.6) + (0.4 * 20% * (1 - 0.4)) ]

= 10.32% + 4.80%

= 15.12%