A firm has a total market value of $10 million and debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of equity is 15% and the tax rate is 35%?
A) 13%
B) 11.6%
C) 8.75%
D) None of the given answers

Question

Quizplus · Accepted Answer

Step 1: Calculate the weights of equity and debt

Weight of equity = Market value of equity / Total market value
= (10 million - 4 million) / 10 million
= 0.6

Weight of debt = Market value of debt / Total market value
= 4 million / 10 million
= 0.4

Step 2: Calculate the after-tax cost of debt

After-tax cost of debt = Before-tax cost of debt x (1 - Tax rate)
= 10% x (1 - 35%)
= 6.5%

Step 3: Calculate the weighted average cost of capital (WACC)

WACC = (Weight of equity x Cost of equity) + (Weight of debt x After-tax cost of debt)
= (0.6 x 15%) + (0.4 x 6.5%)
= 11.6%

A Firm Has a Total Market Value of $10 Million