Using the WACC in practice: Swirlpool, Inc., has found that its cost of common equity capital is 18 percent, and its cost of debt capital is 8 percent. If the firm is financed with 60 percent common shares and 40 percent debt, then what is the after-tax weighted average cost of capital for Swirlpool if it is subject to a 40 percent marginal tax rate?

Question

Quizplus · Accepted Answer

To calculate the weighted average cost of capital (WACC), we need to use the following formula:

WACC = (E/V) x Re + (D/V) x Rd x (1 - T)
where 
E = market value of equity
D = market value of debt
V = E + D
Re = cost of common equity
Rd = cost of debt
T = marginal tax rate

Given that Swirlpool is financed with 60 percent common shares and 40 percent debt, we can calculate the weights as follows:

E/V = 0.6
D/V = 0.4

We also know that:
Re = 18%
Rd = 8%
T = 40%

Using these values, we can plug them into the WACC formula:

WACC = (0.6 x 0.18) + (0.4 x 0.08) x (1 - 0.40)
WACC = 0.108 + 0.024
WACC = 0.132 or 13.2%

However, we need to adjust for the tax rate as the interest on debt is tax-deductible.

So, the after-tax WACC will be:

WACC = 0.132 x (1 - 0.40)
WACC = 0.0792 or 7.92%

Therefore, the answer is C) 12.72%.

Using the WACC in Practice: Swirlpool, Inc