Use the table for the question(s)below.
Consider the information for the following four firms:
-The weighted average cost of capital for "Minie" is closest to:
A)9.50%.
B)9.00%.
C)6.75%.
D)8.25%.

Question

Use the table for the question(s)below.
Consider the information for the following four firms: 
-The weighted average cost of capital for "Minie" is closest to:
A)9.50%. 
B)9.00%. 
C)6.75%. 
D)8.25%.

Quizplus · Accepted Answer

To calculate the weighted average cost of capital (WACC), we first need to find the cost of equity and the cost of debt. From the table, we can see that Minie has only equity and that its cost is 10%. Therefore, the WACC is equal to the cost of equity, which is 10%. However, we also know that the firm has a tax rate of 40%, which means we can calculate the after-tax cost of debt as follows: after-tax cost of debt = cost of debt x (1 - tax rate) = 8% x (1 - 0.40) = 4.8%. Therefore, the total value of debt for the firm is $4 million x 20% = $0.8 million. Using the WACC formula, we get:

WACC = (E/V) x Re + (D/V) x Rd x (1 - T)
where:
E = value of equity = $4 million x 80% = $3.2 million
V = total value of firm = $4 million
D = value of debt = $0.8 million
Re = cost of equity = 10%
Rd = after-tax cost of debt = 4.8%
T = tax rate = 40%

WACC = (3.2/4) x 10% + (0.8/4) x 4.8% x (1 - 0.40) = 8.2%

Therefore, the answer is B) 9.00% (closest to 8.2%).

Use the Table for the Question(s)below