A company's capital structure is made up of 40% debt and 60% common equity (both at market values).The interest rate on bonds similar to those issued by the company is 8%.The cost of equity is estimated to be 15%.The income tax rate is 40%.The company's weighted cost of capital is
A)11.5%.
B)12.2%.
C)10.9%.
D)8)9%.

Question

Quizplus · Accepted Answer

The company's weighted cost of capital (WACC) is calculated as follows:$$ WACC = (E/V \times Re) + ((D/V \times Rd) \times (1 - Tc)) $$Where:- $E/V$ is the proportion of equity in the company's capital structure (60% or 0.60),- $Re$ is the cost of equity (15% or 0.15),- $D/V$ is the proportion of debt in the company's capital structure (40% or 0.40),- $Rd$ is the cost of debt (8% or 0.08),- $Tc$ is the corporate tax rate (40% or 0.40).Plugging in the numbers:$$ WACC = (0.60 \times 0.15) + ((0.40 \times 0.08) \times (1 - 0.40)) $$$$ WACC = 0.09 + (0.032 \times 0.60) $$$$ WACC = 0.09 + 0.0192 $$$$ WACC = 0.1092 $$ or 10.92%, which rounds to 10.9%.

A Company's Capital Structure Is Made Up of 40% Debt