Question

Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate?

Answer 1

11.64%

Step-by-step explanation:

The formula to compute WACC is shown below:

= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of common stock) × (cost of common stock)

where,

Weighted of debt = Debt ÷ total firm

The total firm includes debt, preferred stock, and the equity which equals to

= $3,000,000 + $2,000,000 = $5,000,000

So, Weighted of debt = ($2,000,000 ÷ $5,000,000) = 0.40

And, the weighted of common stock = (Common stock ÷ total firm)

= $3,000,000 ÷ $5,000,0000

= 0.60

Now put these values to the above formula

So, the value would equal to

= (0.40 × 6%) × ( 1 - 40%) + (0.60 × 17%)

= 1.44% + 10.2%

= 11.64%