A firm has a capital structure with $100 million in equity and $100 million of debt.The cost of equity capital is 14% and the pretax cost of debt is 8%.If the marginal tax rate of the firm is 30%,compute the weighted average cost of capital of the firm.

Question

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)where:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtT = marginal tax rateIn this case, we have:E = $100 millionV = $200 millionRe = 14%D = $100 millionRd = 8%T = 30%Substituting these values into the formula, we get:WACC = (100/200) * 0.14 + (100/200) * 0.08 * (1 - 0.3)= 0.07 + 0.042= 0.112 or 11.2%Therefore, the correct answer is A) 9.8%.

A Firm Has a Capital Structure with $100 Million in Equity