Using the build-up method: the risk-free rate, the equity risk premium, the small stock premium, a company-specific risk premium, and an industry risk premium are added together: 3.5% + 6.0% + 4.0% + 3.0% + 2.0% = 18.5%. Note that the risk-free rate is the Treasury yield, not the returns for bonds in general.
Because the firm is being acquired, we assume the new owners will utilize an optimal capital structure and weights in the WACC calculation. The capital structure for public firms should not be used because public firms have better access to debt financing.
The WACC using the optimal capital structure factors in the debt to total cap, the cost of debt, the tax rate, and the given cost of equity:
[20% × 11% × (1-30%)] + [(1-20%) × 18.5%] = 16.3%.
