Question

For a company, you are given: (i) It has 5 million shares outstanding with price 40. (ii) It has 100,000,000 of debt. (iii) Its equity beta is 1. (iv) Its debt cost of capital is 0.06. (v) Its weighted average cost of capital is 0.076. The risk free rate is 0.04 and the market risk premium is 0.05. Calculate the corporate tax rate

Answer 1

WACC= Wd*Rd*(1-T) + We*Re

Where

Wd= Weight of debt, Rd= Cost of debt, T= Tax rate, We= Weight of equity capital and Re= Equity cost of capital.

Given,

WACC= 0.076,

Number of shares= 5,000,000 and price per share= 40

Therefore, value of equity= 5,000,000*40 = 200,000,000

Value of Debt= 100,000,000

Total capital= 100,000,000 + 200,000,000 = 300,000,000

We= 2/3 = 0.6667 and Wd= 1/3 = 0.3333

Risk free rate Rf= 0.04 Market risk premium (MRP) = 0.05 and beta=1

Therefore, cost of equity capital (Re) = Rf+Beta*MRP = 0.04+0.05*1= 0.09

Also given, cost of debt Rd= 0.06

Plugging the values,

0.076= 0.3333*0.06*(1-T) + 0.6667*0.09

0.076= 0.019998-0.019998T + 0.060003

T= (0.076-0.019998-0.060030/-0.019998

Tax rate T= 20.142%