The firm's tax rate is 34%. The firm's pre-tax cost of debt is 8%; the firm's debt-to-equity ratio is 4; the risk-free rate is 3%; the beta of the firm's common stock is 1.5; the market risk premium is 9%. Calculate the weighted average cost of capital.

Question

Quizplus · Accepted Answer

The WACC is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc). First, calculate the cost of equity (Re) using the CAPM: Re = Rf + Beta * Market Risk Premium = 3% + 1.5 * 9% = 16.5%. The after-tax cost of debt (Rd) is 8% * (1-0.34) = 5.28%. The debt-to-equity ratio is 4, so D/E = 4, which implies D/V = 4/5 and E/V = 1/5. Plug these into the WACC formula: WACC = (1/5) * 16.5% + (4/5) * 5.28% = 8.09%.

The Firm's Tax Rate Is 34