Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate?

Question

Quizplus · Accepted Answer

First, we need to calculate the weight of equity capital and debt capital based on their market value:

Weight of Equity = Market Value of Equity / Total Market Value
                    = 3,000,000 / (3,000,000 + 2,000,000)
                    = 0.6 or 60%

Weight of Debt = Market Value of Debt / Total Market Value
                  = 2,000,000 / (3,000,000 + 2,000,000)
                  = 0.4 or 40%

Then, we can use the following formula to calculate the after-tax weighted average cost of capital:

After-tax WACC = (Weight of Equity x Cost of Equity) + (Weight of Debt x (1 - Tax rate) x Cost of Debt)

Plugging in the numbers, we get:

After-tax WACC = (0.6 x 17%) + (0.4 x (1 - 0.4) x 6%)
                       = 11.64%

Therefore, the right choice is C (11.64%).