Question

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?

Answer #1

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%

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