A firm has a total market value of $10 million while its debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the tax rate is 21 percent? (Round to the nearest decimal place).
A)13.0 percent
B)12.2 percent
C)8.8 percent
D)10.4 percent

Question

Quizplus · Accepted Answer

First, we need to calculate the weights of debt and equity:

Weight of debt = $4 million / $10 million = 0.4
Weight of equity = 1 - 0.4 = 0.6

Next, we can calculate the after-tax cost of debt:

After-tax cost of debt = Before-tax cost of debt x (1 - Tax rate) = 10% x (1 - 0.21) = 7.9%

Now, we can calculate the weighted average cost of capital (WACC):

WACC = (Weight of debt x After-tax cost of debt) + (Weight of equity x Cost of equity)
WACC = (0.4 x 7.9%) + (0.6 x 15%)
WACC = 3.16% + 9%
WACC = 12.16%

Therefore, the best choice is B, 12.2 percent.

A Firm Has a Total Market Value of $10 Million