Using the WACC in practice: Maloney's, Inc., has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. If the firm is financed with $3,000,000 of common 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 marginal tax rate?

Question

Quizplus · Accepted Answer

Step 1: Calculate the after-tax cost of debt
After-tax cost of debt = Cost of debt x (1 - Tax rate)
= 0.06 x (1 - 0.4)
= 0.036 or 3.6%
Step 2: Calculate the weight of equity and debt
Weight of equity = Market value of equity / Total financing
= 3000000 / (3000000 + 2000000)
= 0.6 or 60%
Weight of debt = 1 - Weight of equity
= 1 - 0.6
= 0.4 or 40%
Step 3: Calculate the after-tax weighted average cost of capital (WACC)
WACC = (Weight of equity x Cost of equity) + (Weight of debt x After-tax cost of debt)
= (0.6 x 0.17) + (0.4 x 0.036)
= 0.102 or 10.2%
Therefore, the answer is C) 11.64%.

Using the WACC in Practice: Maloney's, Inc