Using the WACC in practice: Maloney's, Ltd., has found that its cost of equity capital is 17 percent and its cost of debt capital is 6 percent. If the company is financed with $3,000,000 of ordinary shares (market value) and $2,000,000 of debt, then what is the after-tax weighted average cost of capital for Maloney's if it is subject to a 40 percent company tax rate?
A) 8.96%
B) 11.16%
C) 11.64%
D) 12.60%

Question

Quizplus · Accepted Answer

First, we need to calculate the weighted average cost of capital (WACC) before tax:

WACC before tax = [($3,000,000 / $5,000,000) x 0.17] + [($2,000,000 / $5,000,000) x 0.06]
WACC before tax = 0.116 = 11.6%

Next, we can calculate the after-tax WACC by adjusting the cost of debt capital to reflect the tax shield gained from interest expenses:

Cost of debt after tax = Cost of debt before tax x (1 - tax rate)
Cost of debt after tax = 0.06 x (1 - 0.4) = 0.036 = 3.6%

After-tax WACC = [($3,000,000 / $5,000,000) x 0.17] + [($2,000,000 / $5,000,000) x 0.036]
After-tax WACC = 0.116 - 0.0048 = 0.1116 = 11.16%

Therefore, the best choice is C, which is the after-tax WACC calculated above.

Using the WACC in Practice: Maloney's, Ltd