Question

A company is 47% financed by risk-free debt. The interest rate is 12%, the expected market risk premium is 10%, and the beta of the company’s common stock is 0.57. What is the after-tax WACC, assuming that the company pays tax at a 30% rate?

a. 12.45%

b. 12.77%

c. 13.02%

d. 13.18%

e. 13.33%

Answer 1

Ans : Assumed Risk Free Rate is 12% since it is the interest rate on Risk-free debt.
Debt Proportion = 0.47
Equity Proportion = 0.53

Step 1 : Cost of Equity

Ke = Risk Free Rate + Beta * (Market Premium)
= 12% + 0.57 * (10%)
= 17.7%

Step 2 : Cost of Debt after Tax

Kd = Cost of Debt - Tax Rate = 12 - 30% = 8.4%

Step 3 : WACC

WACC = ( Cost of Equity * Equity Proportion ) + ( Cost of Debt * Debt Proportion )
= (17.7% * 0.53) + (8.4% + 0.47 )
= 9.38% + 3.95%
= 13.33%
  
Ans : After - Tax WACC = 13.33% . Option (e) is correct.