Qantas is discussing new ways to recapitalise the firm and raise additional capital. Its current capital structure has a 10% weight in ordinary shares, 20% in preference shares, and 70% in debt. The cost of equity capital is 15%, the cost of preference shares is 10%, and the pre-tax cost of debt is 8%. What is the weighted average cost of capital for Qantas if its marginal tax rate is 30%?

Question

Quizplus · Accepted Answer

First, we need to calculate the weights of each source of capital:
- Ordinary shares: 10%
- Preference shares: 20%
- Debt: 70%

Next, we need to calculate the after-tax cost of each source of capital:
- Cost of equity: 15%
- Cost of preference shares: 10%
- Pre-tax cost of debt: 8%
Since we know the marginal tax rate is 30%, we can find the after-tax cost of debt:
After-tax cost of debt = Pre-tax cost of debt x (1 - Marginal tax rate) = 8% x (1 - 0.3) = 5.6%

Finally, we can calculate the weighted average cost of capital (WACC) using the following formula:
WACC = (Weight of equity x Cost of equity) + (Weight of preference shares x Cost of preference shares) + (Weight of debt x After-tax cost of debt)
WACC = (0.1 x 0.15) + (0.2 x 0.1) + (0.7 x 0.056) = 0.015 + 0.02 + 0.0392 = 0.0742 or 7.42%

Therefore, the best choice is C because it correctly calculates the WACC.

Qantas Is Discussing New Ways to Recapitalise the Firm and Raise