You are an investment banker trying to value ABC Corp, a private software company. You have forecasted ABC’s free cash flows, but need to compute its WACC in order to value the firm. Unfortunately, ABC is private and so it does not have stock data, so you cannot use CAPM to find its cost of equity.

You know the following: ABC has debt of $200 at a cost of 5%; ABC recently raised money from equity investors, valuing the equity at $1,000. Further, Microsoft is in the same exact business as ABC, but it is public so you can see its cost of equity. Microsoft is financed with a constant debt-to-equity ratio of 1/9, has a cost of debt of 3%, a cost of equity of 20%, and a tax rate of 30%.

[Step 1: De-levering] Find the cost of unlevered equity for ABC (which is the same for Microsoft). Assume that Microsoft’s debt-to-equity ratio will stay constant forever.

A.18.3%
B.22.2%
C.22.5%
D.24.3%

[Step 2: Re-levering] Using the unlevered cost of capital for ABC above, find the cost of levered equity for ABC (assuming that ABC’s capital structure D/E will remain fixed).

A.23.32%
B.25.43%
C.20.96%
D.28.25%

Using your above two answers, find ABC’s WACC assuming it has the same tax rate as Microsoft.

A.20.05%
B.23.05%
C.25.05%
D.18.05%