A firm has a capital structure with $50 million in equity and $100 million of debt.The cost of equity capital is 12% and the pretax cost of debt is 7%.If the marginal tax rate of the firm is 40%,compute the weighted average cost of capital of the firm.

Question

Quizplus · Accepted Answer

Weighted Average Cost of Capital (WACC) is calculated as follows:

WACC = (E/V) Re + (D/V) Rd (1-Tc)

where, 
E = Equity
D = Debt
V = Total value of firm (E + D)
Re = Cost of equity
Rd = Pretax cost of debt
Tc = Marginal tax rate

Substituting the given values, we get:

WACC = (50/150) x 0.12 + (100/150) x 0.07 (1-0.4)
     = 0.08 + 0.042
     = 0.122 or 12.2%

Therefore, the correct answer is C) 6.8%.

A Firm Has a Capital Structure with $50 Million in Equity