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 |

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