Question

PQR Company has the following: Borrowing rate of 7.0% Cost of equity of 25.0% Corporate tax...

PQR Company has the following:

Borrowing rate of 7.0%

Cost of equity of 25.0%

Corporate tax rate of 21.0%

Book value of debt = $630,000

Book value of equity = $1,250,000

Market value of debt = $630,000

Market Value of equity = $2,750,000

PQR Company’s weighted average cost of capital (WACC) is:

21.6%

19.0%

21.4%

18.5%

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Homework Answers

Answer #1

The Correct answer is 21.4%

The Weighted Average Cost of Capital or the cost of capital is calculated using the formula

Cost of Equity * Weight allocated to equity + Cost of debt * Weight allocated to debt* (1-Tax rate)

These weights are based on the market values.

  • Cost of Equity = 25.0%
  • Cost of Debt = 7.0%
  • Tax rate = 21.0%
  • Market Value of Debt = $630,000
  • Market Value of Equity = $2,750,000

Total market value = $630,000 + $2,750,000

= $3,380,000

Calculation of Weights

Weight allocated to equity = $2,750,000 / $3,380,000

= 0.8136 or 81.36%

Weight allocated to Debt = 100% - 81.36%

= 18.64 or 0.1864

Calculation of WACC

= 0.8136 * 25.0 + 0.1864 * 7 (1-0.21)

= 20.34 + .1864 * 5.53

= 20.34 + 1.0308

= 21.37 or 21.4%

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