Question

# A company has a cost of common equity capital of 17 % and its cost of...

A company has a cost of common equity capital of 17 % and its cost of debt capital is 6 %. The firm is financed with \$3,000,000 of common shares (market value) and \$2,000,000 of debt. What is its after-tax weighted average cost of capital if it is subject to a 25 % tax rate?

Debt:

Market Value of Debt = \$2,000,000

Before-tax Cost of Debt = 6.00%
After-tax Cost of Debt = 6.00% * (1 - 0.25)
After-tax Cost of Debt = 4.50%

Equity:

Market Value of Equity = \$3,000,000

Cost of Equity = 17.00%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = \$2,000,000 + \$3,000,000
Market Value of Firm = \$5,000,000

Weight of Debt = \$2,000,000 / \$5,000,000
Weight of Debt = 0.40

Weight of Equity = \$3,000,000 / \$5,000,000
Weight of Equity = 0.60

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity *Cost of Equity
WACC = 0.40 * 4.50% + 0.60 * 17.00%
WACC = 12.00%