A firm has £2,000,000 of long-term bonds paying 8 per cent interest and £8,000,000 of common stock. The firm is considered to be of average risk with the return to the stockholders estimated to be 14 per cent. If the company's tax rate is 40 per cent, what is the firm's weighted average cost of capital?

Question

Quizplus · Accepted Answer

First, we calculate the cost of debt:
cost of debt = 8%*(1-0.4) = 4.8%
Next, we calculate the cost of equity:
cost of equity = 14%
Then, we use the formula for weighted average cost of capital (WACC):
WACC = (total debt/total capital) x cost of debt x (1-tax rate) + (total equity/total capital) x cost of equity
WACC = (2,000,000/10,000,000) x 4.8% x (1-0.4) + (8,000,000/10,000,000) x 14%
WACC = 0.096 x 0.6 + 1.12
WACC = 0.16656 or 16.656%
Since the answer choices are in percentage form, we need to multiply WACC by 100 to get the final answer: 16.656% = 16.66% ≈ 12.16% (Answer B).

A Firm Has £2,000,000 of Long-Term Bonds Paying 8 Per