Tardy Clocks Inc.(TC)has long term bonds with a face value of $6M,the coupon rate on the bonds is 6% and the yield on the bonds is also 6%.The unlevered cost of equity is 10% and the value of TC's equity is $9.1M.The corporate tax rate is 35%.What is Tardy's WACC?
A) 6.42%
B) 7.89%
C) 8.61%
D) 9.44%
E) 11.71%

Question

Quizplus · Accepted Answer

This solution uses Modigliani & Miller Proposition II with taxes. First, find the cost of equity for a levered firm: k_E = k_U + (k_U - k_D) × (1 - T) 11ea7fdb_fc67_aef2_a768_79b5c9fbe2ce_TB2902_11 k_E = 0.10 + (0.10 - 0.06) × (1 - 0.35) × 11ea7fdb_fc67_aef3_a768_e75c51327f0b_TB2902_11 = 0.1171 or 11.71% Now, calculate WACC: WACC = 11ea7fdb_fc67_aef4_a768_b5a4381694ae_TB2902_11 k_E + 11ea7fdb_fc67_d605_a768_03fcd3627106_TB2902_11 k_D(1 - T) WACC = 11ea7fdb_fc67_d606_a768_d394db3f8639_TB2902_11 × 0.1171 + 11ea7fdb_fc67_d607_a768_af4678459ac7_TB2902_11 × 0.06 x (1 -0.35) = 8.61%