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

Question

Quizplus · Accepted Answer

The formula for weighted average cost of capital (WACC) is:
WACC = (E/V)x Re + (D/V) x Rd x (1 - T)

where:
E = market value of equity
D = market value of debt
V = total market value of the firm = E + D
Re = cost of equity
Rd = cost of debt
T = corporate tax rate

Using the given information: 
- debt-to-total-market-value ratio = 40%, so equity-to-total-market-value ratio = 60%
- Re (cost of levered equity capital) = 13%
- Rd (after-tax cost of debt) = I x (1 - T) = 8% x (1 - 0.3) = 5.6%

So, plugging in the values:
WACC = (0.6 x 0.13) + (0.4 x 0.056 x 0.7) = 0.078 + 0.0157 = 0.0937 or 9.37%

Therefore, the best answer choice is C) 10%, as it is the closest option to the calculated WACC of 9.37%.

Assume That XYZ Corporation Is a Levered Company with the Following