Question

Rumolt Motors has 38 million shares outstanding with a share price of $ 43 per share. In​ addition, Rumolt has issued bonds with a total current market value of $ 1 comma 975 million. Suppose​ Rumolt's equity cost of capital is 14 %​, and its debt cost of capital is 5 %.

a. What is​ Rumolt's pre-tax​ WACC?

b. If​ Rumolt's corporate tax rate is 30 %​, what is its​ after-tax WACC?

Answer 1

a

Equity value = price*shares = 43*38=1634m

Total Capital value = Value of Equity + Value of Debt

=1634+1975

=3609

Weight of Equity = Value of Equity/Total Capital Value

= 1634/3609

=0.4528

Weight of Debt = Value of Debt/Total Capital Value

= 1975/3609

=0.5472

Cost of Capital = Weight of Equity*Cost of Equity+Weight of Debt*Cost of Debt

Cost of Capital = 14*0.4528+5*0.5472

Cost of Capital = 9.0748

b

After tax cost of debt =debt cost*(1-tax rate) = 5*(1-0.3)=3.5%

After tax Cost of Capital = Weight of Equity*After tax Cost of Equity+Weight of Debt*After tax Cost of Debt

After tax Cost of Capital = 14*0.4528+3.5*0.5472

After tax Cost of Capital = 8.2539