Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $8,000,000 and an interest rate of 8%, and equity capital with a market value of $12,000,000 and a cost of equity of 12%. What is Springfield's weighted average cost of capital (WACC)?
A).0480
B).0800
C).0912
D).1000

Question

Quizplus · Accepted Answer

To calculate WACC, we need to first determine the proportion of debt and equity in the company's capital structure.

Proportion of Debt = Market value of Debt / Total Market Value 
Proportion of Debt = 8,000,000 / (8,000,000 + 12,000,000) = 0.4

Proportion of Equity = Market value of Equity / Total Market Value 
Proportion of Equity = 12,000,000 / (8,000,000 + 12,000,000) = 0.6

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

After-tax Cost of Debt = Interest rate * (1 - Tax rate) 
After-tax Cost of Debt = 8% * (1 - 0.4) = 4.8%

Finally, we can calculate the WACC:

WACC = (Proportion of Debt * After-tax Cost of Debt) + (Proportion of Equity * Cost of Equity) 
WACC = (0.4 * 4.8%) + (0.6 * 12%) = 9.12%

Therefore, the correct answer is C.

Springfield Corporation, Whose Tax Rate Is 40%, Has Two Sources