Question

17. Rumolt Motors has 25 million shares outstanding with a share price of $28 per share. In​ addition, Rumolt has issued bonds with a total current market value of $192 million. Suppose​ Rumolt's equity cost of capital is 14%​, and its debt cost of capital is 7%.
a. What is​ Rumolt's pre-tax​ WACC?
b. If​ Rumolt's corporate tax rate is 21%​, what is its​ after-tax WACC?

Answer 1

a. Pretax WACC is computed as follows:

= cost of debt x weight of debt + cost of equity x weight of equity

= 0.07 x $ 192 million / (25 million shares x $ 28 + $ 192 million ) + 0.14 x (25 million shares x $ 28) / (25 million shares x $ 28 + $ 192 million)

= 0.07 x $ 192 million / $ 892 million + 0.14 x $ 700 million / $ 892 million

= 0.07 x 0.215246637 + 0.14 x 0.784753363

= 12.49% Approximately

b. The WACC is computed as follows:

= cost of debt x (1 - tax rate) x weight of debt + cost of equity x weight of equity

= 0.07 x 0.79 x $ 192 million / (25 million shares x $ 28 + $ 192 million ) + 0.14 x (25 million shares x $ 28) / (25 million shares x $ 28 + $ 192 million)

= 0.07 x 0.79 x $ 192 million / $ 892 million + 0.14 x $ 700 million / $ 892 million

= 0.0553 x 0.215246637 + 0.14 x 0.784753363

= 12.18% Approximately