A firm has a capital structure with $30 million in equity and $90 million of debt.The cost of equity capital is 10% and the pretax cost of debt is 6%.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 given by the formula:

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

Where,

E = Market value of equity = $30 million
D = Market value of debt = $90 million
V = Total value of the firm = E + D = $120 million
Re = Cost of equity = 10%
Rd = Pretax cost of debt = 6%
Tc = Marginal tax rate = 40%

Plugging in these values in the formula:

WACC = (30/120 * 10%) + (90/120 * 6%) * (1-40%)
WACC = 5.2%

Therefore, the best choice is C.

A Firm Has a Capital Structure with $30 Million in Equity