Boob-Tube Electronics Inc.has long term bonds with a face value of $2M,the coupon rate on the bonds is 5% and the yield on the bonds is also 5%.The unlevered cost of equity is 12.5%,and the value of Boob-Tube's equity is $3.6M.The corporate tax rate is 40%.What is Boob-Tube's WACC?

Question

Quizplus · Accepted Answer

This solution uses Modigliani & Miller Proposition II with taxes. First, find the cost of equity for a levered firm: k_E = k_U + (k_U - k_D) × (1 - T) 11ea7fdb_fc67_fd18_a768_89331b450a2b_TB2902_11 k_E = 0.125 + (0.125 - 0.05) × (1 - 0.40) × 11ea7fdb_fc67_fd19_a768_dd147f23fd99_TB2902_11 = 0.15 or 15% Now, calculate WACC: WACC = 11ea7fdb_fc67_fd1a_a768_d94d946fb51e_TB2902_11 k_E + 11ea7fdb_fc67_fd1b_a768_b5d651ab04b3_TB2902_11 k_D(1 - T) WACC = 11ea7fdb_fc68_242c_a768_075022614228_TB2902_11 × 0.15 + 11ea7fdb_fc68_242d_a768_d59e28c0e70a_TB2902_11 × 0.05 x (1 - 0.40) = 10.71%