A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75 percent. The firm's cost of equity is 16 percent and it has a tax rate of 30 percent. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?
A)6.89 percent
B)6.28 percent
C)5.97 percent
D)5.71 percent

Question

Quizplus · Accepted Answer

WACC = (Weight of Equity x Cost of Equity) + (Weight of Debt x Cost of Debt x (1 - Tax Rate))
13% = (0.75 x 16%) + (0.25 x Cost of Debt x (1 - 30%))
Solving for Cost of Debt, we get:
Cost of Debt = (13% - (0.75 x 16%)) ÷ (0.25 x (1 - 30%))
Cost of Debt = 5.71%

A Firm Uses Only Debt and Equity in Its Capital