The DEF Company is planning a $64 million expansion.The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock.The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent.If the company is in the 35 percent tax bracket,what is the firm's cost of capital?

Question

Quizplus · Accepted Answer

The firm's cost of capital can be calculated using the weighted average cost of capital (WACC) formula: WACC = (E/V * Re) + ((D/V * Rd) * (1 - Tc)), where E is the market value of the equity, D is the market value of the debt, V = E + D is the total market value of the firm's financing (equity and debt), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Plugging in the given values: E = $38.4 million, D = $25.6 million, V = $64 million, Re = 14%, Rd = 9%, and Tc = 35%. WACC = ($38.4/$64 * 14%) + ($25.6/$64 * 9% * (1 - 0.35)) = 0.1074 or 10.74%.

The DEF Company Is Planning a $64 Million Expansion