Assume that XYZ Corporation is a levered company with the following information: K_l = cost of levered equity capital for XYZ = 13 percent
I = before-tax borrowing cost = 8 percent
T = marginal corporate income tax rate = 30 percent
If XYZ's debt-to-total-market-value ratio is 40 percent,then its weighted average cost of capital,K,is

Question

Quizplus · Accepted Answer

First, calculate the cost of debt after taxes by multiplying the before-tax borrowing cost by (1-T): 
8% * (1-0.30) = 5.6%

Next, calculate the cost of equity using the formula: 
KS = KS1 + (KS1 - I) x D/V 
where KS1 = cost of unlevered equity 
I = before-tax borrowing cost 
D/V = debt-to-value ratio

Assuming that the cost of unlevered equity for XYZ is 10 percent, we get: 
KS = 10% + (13% - 5.6%) x 0.4 
KS = 10% + 3.36% 
KS = 13.36%

Finally, calculate the weighted average cost of capital (WACC) using the formula: 
WACC = (E/V x KS) + (D/V x KD x (1-T)) 
where E/V = equity-to-value ratio 
KD = cost of debt 
D/V = debt-to-value ratio

Assuming that the equity-to-value ratio is 60%, we get: 
WACC = (0.6 x 13.36%) + (0.4 x 5.6% x 0.7) 
WACC = 8.016% + 1.984% 
WACC = 10%

Therefore, the answer is C) 10 percent.

Assume That XYZ Corporation Is a Levered Company with the Following