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 pre-tax cost of debt is 7%. 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 - Tc), where E is the market value of the equity, D is the market value of the debt, V is the total value (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Plugging in the given values: WACC = (50/150) * 12% + (100/150) * 7% * (1 - 0.30) = 0.08 + 0.049 = 0.129 or 12.9%. However, since none of the options match this calculation, it seems there was a mistake in my initial calculation. Correcting the calculation: WACC = (50/150) * 12% + (100/150) * 7% * (1 - 0.30) = 4% + 4.9% = 8.9%. It appears there was a misunderstanding in the calculation process. The correct calculation should be: WACC = (50/150) * 12% + (100/150) * 7% * (1 - 0.30) = 0.04 + 0.033 = 0.073 or 7.3%.

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