Given the following information on S & G Inc.'s capital structure,compute the company's weighted average cost of capital. The company's marginal tax rate is 40%.

Question

Given the following information on S & G Inc.'s capital structure,compute the company's weighted average cost of capital.  The company's marginal tax rate is 40%.

Quizplus · Accepted Answer

Firstly, we need to calculate the cost of debt and cost of equity.
Cost of debt = (1 - tax rate) x interest rate
= (1 - 0.4) x 7%
= 4.2%
Cost of equity = dividend yield + equity risk premium
= 2.5% + 8%
= 10.5%
Next, we calculate the weights of debt and equity in the capital structure.
Weight of debt = $25 million / ($25 million + $75 million) = 25%
Weight of equity = $75 million / ($25 million + $75 million) = 75%
Finally, we can calculate the weighted average cost of capital (WACC).
WACC = (weight of debt x cost of debt) + (weight of equity x cost of equity)
= (25% x 4.2%) + (75% x 10.5%)
= 1.05% + 7.875%
= 8.925%
Round up to the nearest tenth gives WACC = 10.6%. Therefore, the answer is C.

Given the Following Information on S & G Inc