Durocorp has a target capital structure of 30% debt and 70% equity.Durocorp is planning to invest in a project that will necessitate raising new capital.New debt will be issued at a before-tax yield of 14%,with a coupon rate of 10%.The equity will be provided by internally generated funds so no new outside equity will be issued.If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%,compute the firm's cost of capital.
A) 18.00%
B) 18.13%
C) 19.68%
D) 15.55%

Question

Quizplus · Accepted Answer

First, calculate the cost of debt:
Before-tax cost of debt = 14%
After-tax cost of debt = 10% x (1 - marginal tax rate) = 6.5%
Next, calculate the cost of equity:
Cost of equity = required rate of return on stock = 22%
Finally, calculate the weighted average cost of capital (WACC):
WACC = (weight of debt x after-tax cost of debt) + (weight of equity x cost of equity)
WACC = (0.3 x 6.5%) + (0.7 x 22%) = 15.05%
Therefore, the answer is B) 18.13%.

Durocorp Has a Target Capital Structure of 30% Debt and 70