M&M Proposition 2: Melba's Toast has a capital structure with 30% debt and 70% equity. Its pretax cost of debt is 6%, and its cost of equity is 10%. The company's marginal corporate income tax rate is 35%. What is the appropriate WACC?
A) 8.17%
B) 6.35%
C) 8.80%
D) 7.44%

Question

Quizplus · Accepted Answer

The correct answer is A because the WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:E = market value of equityV = market value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = corporate income tax rateIn this case, we have:E/V = 70%Re = 10%D/V = 30%Rd = 6%Tc = 35%Plugging these values into the formula, we get:WACC = (0.7) * 0.1 + (0.3) * 0.06 * (1 - 0.35) = 0.0817 = 8.17%

M&M Proposition 2: Melba's Toast Has a Capital Structure with 30