A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 30 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?
A)7.17 percent
B)9.05 percent
C)6.38 percent
D)5.36 percent

Question

Quizplus · Accepted Answer

WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * Cost of Debt) * (1 - Tax Rate)

11% = (0.70 * 13%) + (0.30 * Cost of Debt) * (1 - 0.30)

Solving for Cost of Debt, we get:

Cost of Debt = (11% - 9.1%) / 0.3

Cost of Debt = 6.33%

Before-tax cost of debt = 6.33% / (1 - 0.30) = 9.05%

Therefore, the before-tax cost of debt is 9.05 percent, and the best choice is B.

A Firm Uses Only Debt and Equity in Its Capital