A firm has a capital structure with $50 million in equity and $100 million of debt. The cost of equity capital is 12% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 30%, compute the weighted average cost of capital of the firm.

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Quizplus · Accepted Answer

The WACC is calculated as follows: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc), where E = equity, D = debt, V = E + D, Re = cost of equity, Rd = cost of debt, and Tc = tax rate. Here, E = $50 million, D = $100 million, V = $150 million, Re = 12%, Rd = 7%, Tc = 30%. WACC = (50/150) * 12% + (100/150) * 7% * (1-0.3) = 4% + 3.27% = 7.27%, approximately 7.3%.

A Firm Has a Capital Structure with $50 Million in Equity