Question

Assuming that the debt amount is $3 million and the equity amount is $7 million. The cost
of debt is 14% and the cost of equity is 18%. Find the cost of capital (WACC) if the corporation tax rate on income is 40%.

Answer 1

Answer :

Calculation of WACC (Cost of Capital)

WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity)

Cost of After Tax Debt = Cost of Debt * (1 - tax rate)

= 14% * (1 - 0.40)

= 8.4%

Cost of Equity (Given) = 18%

Weight of Debt = Value of Debt / (Value of Debt + Value of Equity)

= 3 / ( 3 + 7)

= 3 / 10

= 0.30

Weight of Equity = Value of Equity / (Value of Debt + Value of Equity)

= 7 / ( 3 + 7)

= 7 / 10

= 0.70

WACC = (8.4% * 0.30) + ( 18% * 0.70)

= 2.52% + 12.6%

= 15.12%