Question

The management at ABC Co will consider the tax effect on the cost of capital for...

The management at ABC Co will consider the tax effect on the cost of capital for new capital projects, the current policy of capital structure is 40% debt, 60% common shares (no preferred stock), cost of financing 7%, retained earnings financing cost is 14%, compute the WACC for the following tax assumptions 39%, 36%, 25%, all else being equal if the tax rate goes up, what is the effect on WACC?

Homework Answers

Answer #1

WACC=(weight of debt*after tax cost of debt)+(weight of equity*cost of equity)

a. If tax=39%

after tax cost of debt=cost of financing*(1-tax rate)=7%*(1-39%)=4.27%

WACC=(40%*4.27%)+(60%*14%)=10.11%

b. If tax=36%

after tax cost of debt=cost of financing*(1-tax rate)=7%*(1-36%)=4.48%

WACC=(40%*4.48%)+(60%*14%)=10.19%

c. If tax=25%

after tax cost of debt=cost of financing*(1-tax rate)=7%*(1-25%)=5.25%

WACC=(40%*4.48%)+(60%*14%)=10.50%

2. If tax rate goes up, the WACC decreases which is a good thing.

Becasue of the tax advantage on the debt, higher tax results in decrease in the WACC.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
The effect of tax rate on WACC K. Bell Jewelers wishes to explore the effect on...
The effect of tax rate on WACC K. Bell Jewelers wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 20​% ​debt, 20​% preferred​ stock, and 60 % common stock. The cost of financing with retained earnings is 16​%, the cost of preferred stock financing is 9​%, and the​ before-tax cost of debt financing is 8​%. Calculate the weighted average cost of...
You are the finance manager for delta enterprise. You are calculating the cost of capital for...
You are the finance manager for delta enterprise. You are calculating the cost of capital for your company. You want to maintain a capital structure of 25% debt, 25% preferred stock, and 50% common stock. The cost of financing with retained earnings is 12%, the cost of preferred stock financing is 8.5%, and the before-tax cost of debt financing is 8%, Calculate the weighted average cost of capital (WACC) given the tax rate is 45%. What will be the effect...
Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt,...
Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current...
Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt,...
Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. 1) If its...
Which of the following statements is true of the impact of tax on the cost of...
Which of the following statements is true of the impact of tax on the cost of capital of a firm?​ Select one: a. ​All else being equal, an increase in the corporate tax rate results in a decrease in the weighted average cost of capital. b. ​The before-tax cost of debt is the cheapest component of the cost of capital since the tax paid is a deductible expense. c. ​The before-tax cost of debt is always less than the after-tax...
QUESTION 41 CGI Co. has a desired capital structure of 10-40-50 (preferred shares, debt, and ordinary...
QUESTION 41 CGI Co. has a desired capital structure of 10-40-50 (preferred shares, debt, and ordinary shares, respectively). The tax rate shifted from 24% to 32%. Other information: Before-tax cost of preferred stock: 8% Before-tax cost of common stock: 14% Before-tax cost debt: 6% What is the new WACC of CGI Inc.? a. 9.33% b. 9.43% c. 10.2%
The Evans Corporation finds that it is necessary to determine its marginal cost of capital. Evans'...
The Evans Corporation finds that it is necessary to determine its marginal cost of capital. Evans' current capital structure calls for 30 percent debt, 10 percent preferred stock, and 60 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 6.2 percent; preferred stock, 9.4 percent; retained earnings, 12 percent; and new common stock, 13.4 percent. What...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the...
The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT
Active Questions
  • John knows that monthly demand for his product follows a normal distribution with a mean of...
    asked 2 minutes ago
  • No one theory can account for all crimes. which theory of crime causation do you think...
    asked 12 minutes ago
  • Based on the below data: Customer1:Bread,Cereals,Milk Customer2:Tomatoes,Eggs Customer3:Pork,Bread,Milk Customer4:Sugar,Tomatoes,Pork,Bread Customer5:Vinegar Customer6:Eggs,Milk,Cereals,Sugar,Pork Customer7:Eggs,Milk,Vinegar Customer8:Sugar,Pork explain h
    asked 14 minutes ago
  • Pleas write a program that checks if any array of string is a plaindrome required input:...
    asked 20 minutes ago
  • A parallel-plate capacitor with plates of area 720 cm2 is charged to a potential difference V...
    asked 23 minutes ago
  • Develop an algorithm and a program in C that asks the user to enter a positive...
    asked 24 minutes ago
  • The principal of Paul Revere High School bragged that his 2016 graduating class of 1500 students...
    asked 26 minutes ago
  • Height is normally distributed with a mean of 68 inches and a standard deviation of 3...
    asked 26 minutes ago
  • Say you want to build an instrument to separate visible light from a light source into...
    asked 36 minutes ago
  • Engage in a comparison of the “derivative action” and the actionrelatingto“unfair prejudice to members’interests”. In what...
    asked 37 minutes ago
  • Suppose that grade point averages of undergraduate students at one university have a bell-shaped distribution with...
    asked 41 minutes ago
  • A 0.0270 kg bullet moving horizontally at 400 m/s embeds itself into an initially stationary 0.500...
    asked 43 minutes ago