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 firm's marginal corporate income tax rate is 35%. What is the appropriate WACC?

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 = (0.70) * 0.10 + (0.30) * 0.06 * (1 - 0.35)= 0.07 + 0.0126= 0.0826 or 8.26%

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