Question

a) ABC Inc. borrows money at 9%, sells bonds at 6%, and the purchasers of common stock require 12% rate of return. If the company has borrowed $40 million, sold $60 million in bonds, and sold $100 million worth of common stocks, what is the Weighted Average Cost of Capital (WACC)?

b) If the same company from the previous question used 6% ROR for loans, 7% ROR for bonds, and 13% ROR for stocks, and also used a 50% tax rate, what is the WACC?

Answer 1

a.The following is the calculation of WACC:

source	amount	weight	cost	weight * cost
borrowing	$40 m	(40/200)=>0.20	9%	1.8%
bonds	$60 m	(60/200)=>0.30	6%	1.8%
common stock	$100 m	(100/200)=>0.50	12%	6.0%
total	$200 m			9.60%

b.

since the tax rate is 50%.

after tax cost of borrowing = before tax cost *(1 - tax rate)

=>6% *(1-0.50)

=>3%

after tax cost of bonds = 7% * (1-0.50) =>3.50%

source	amount	weight	cost	weight * cost
borrowing	$40 m	(40/200)=>0.20	3%	0.6%
bonds	$60 m	(60/200)=>0.30	3.5%	1.05%
common stock	$100 m	(100/200)=>0.50	13%	6.5%
total	$200 m			8.15%