A firm has a total market value of $10 million while its debt has a market value of $4 million.What is the after-tax weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the tax rate is 35 percent?
A)13 percent
B)11.6 percent
C)8.8 percent
D)10.4 percent

Question

Quizplus · Accepted Answer

Weight of equity = ($10 million - $4 million)/$10 million = 0.6
Weight of debt = $4 million/$10 million = 0.4

After-tax cost of debt = before-tax cost of debt * (1 - tax rate) = 10% * (1 - 0.35) = 6.5%

WACC = (Weight of equity * Cost of equity) + (Weight of debt * After-tax cost of debt)
WACC = (0.6 * 15%) + (0.4 * 6.5%) = 9% + 2.6%
WACC = 11.6%

A Firm Has a Total Market Value of $10 Million