4-3 Calculating a Firm's WACC Nestl En- terprises is estimating its cost of capital for the first time and has made the following es- timates: The firm's debt carries a AAA rating, which is currently yielding 6%; the firm pays taxes at a rate of 30%; the cost of equity is estimated to be 14%; and the firm's debt is equal to 20% of its enterprise value. a. What is Nestls estimated WACC? b. If Nestl were to increase its debt level to 40% of enterprise value, the firm's investment banker has told the firm that its credit rating would drop to AA and correspondingly its cost of debt financing would rise to 7%. If the cost of equity corresponding to this new capital structure were to rise to 16%, what would be the firm's estimated WACC? PROBLEM 4-3 2 3 Given 5 6 Cost of debt Tax Rate Cost of equity Debt/EV 7 6% 30% 14% 20% 8 9 10 Part a. Source Debt Equity Solution Proportion After-tax cost Product 4% WACC 11 12 13 14 15 16 17 18 19 20 21 22 23 Part b. Solution Proportion After-tax cost Product Source Debt Equity WACC 24