Question

Lawler's is considering a new project. The company has a debt-equity ratio of 0.64. The company's cost of equity is 14.9 percent, and the aftertax cost of debt is 5.3 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of 1.8 percent. What is the project cost of capital if the tax rate is 34 percent?

a. 12.53 percent
b. 12.98 percent
c. 12.95 percent
d. 15.14 percent
e. 15.68 percent

Answer 1

C) 12.95 percent

Step-by-step explanation:

weighted average cost of capital(WACC) can be calculated as [(the weights of equity)×(the cost of each component) ]+ [weights of debt in the total capital structure × the cost of each component × (1+ tax rate)]

We need the value of our weight of debt as well as weight of equity in total capital structure, But we were given

debt to equity ratio as 0.64, then we can say there is debt of 0.64 in a solar of equity,

Total Asset = addition of equity and debt, total 1+ 0.64

= 1.64

Then Weight of debt is ratio of debt to equity ratio and total asset= (0.64 / 1.64 )

= 16/41

=0.39

The equity weight is ratio of 1dollar and total asset

= (1 / 1.64 )= 25/41

=0.61

weighted average cost of capital(WACC) can be calculated as [(the weights of equity)×(the cost of each component) ]+ [weights of debt in the total capital structure × the cost of each component × (1+ tax rate)]

If we substitute we have

(0.149×0.61)+(0.053×0.39)

= 0.1115

If we find percentage we have 11.15%

From the question, the adjustment factor is +1.8 percent.

then project cost of capital if the tax rate is 34 percent is (11.15% + 1.8%)

= 12.95%