Aswath Damodaran 317
Applying Cost of Capital Approach: The Textbook Example
D/(D+E) ke kd After-tax Cost of DebtWACC
0 10.50% 8% 4.80% 10.50%
10% 11% 8.50% 5.10% 10.41%
20% 11.60% 9.00% 5.40% 10.36%
30% 12.30% 9.00% 5.40% 10.23%
40% 13.10% 9.50% 5.70% 10.14%
50% 14% 10.50% 6.30% 10.15%
60% 15% 12% 7.20% 10.32%
70% 16.10%13.50% 8.10% 10.50%
80% 17.20% 15% 9.00% 10.64%
90% 18.40% 17% 10.20% 11.02%
100% 19.70% 19% 11.40% 11.40%
This is a simple example, where both the costs of debt and equity are given.
Note that both increase as the debt ratio goes up, but the cost of capital becomes
lower at least initially as you take on more debt ( because you are substituting in
cheaper debt for more expensive equity)
At 40%, the cost of capital is minimized. It is the optimal debt ratio.
