Question

A firm finances a $40 million project by borrowing $20 million to be repaid over the life of the project and by issuing common stocks worth of $20 million. Determine the required rate of return, both before- and after-tax. Borrowed funds cost 10%, equity costs 20%, and the tax rate is 40%. Revenue (R) will be independent of the financing method

A: 6 million

B:2million
C:3.5million
D:1.5million
E:7million

Answer 1

before tax required rate of return
source	value	weight	component cost	weight*component cost
debt	20	0.5	10%	0.05
equity	20	0.5	20%	0.1
total	40
WACC = sum of weight*component cost				15%
After tax required rate of return
source	value	weight	component cost	weight*component cost
debt	20	0.5	6%	0.03
equity	20	0.5	20%	0.1
total	40
WACC = sum of weight*component cost				13%
after tax cost of debt	before tax cost of debt*(1-tax rate)	10*(1-.4)		6%