Your ﬁrm has expected earnings before interest and taxes of $2,400. Your unlevered cost of capital is 12% and your tax rate is 35%. You have debt with both a book and a market value of $5,000. This
Debt has a 7% coupon and pays interest annually. What is your weighted average cost of capital?
A) 10.02%
B) 10.21%
C) 10.32%
D) 10.58%
E) 11.23%

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax cost of debt:
After-tax cost of debt = (1 - tax rate) x coupon rate
= (1 - 0.35) x 0.07
= 0.0455 or 4.55%
Next, we need to calculate the weighted average cost of capital (WACC):
WACC = (unlevered cost of capital x value of equity) + (after-tax cost of debt x value of debt ÷ value of equity + value of debt)
Value of equity = (EBIT - interest) ÷ unlevered cost of capital
= (2400 - (5000 x 0.07)) ÷ 0.12
= 1200
Therefore, value of debt = 5000
WACC = (0.12 x 1200) + (0.0455 x 5000 ÷ (1200+5000))
= 0.1029 or 10.29%
The closest answer choice to our calculation is D) 10.58%.

Your ﬁRm Has Expected Earnings Before Interest and Taxes of $2,400