Question

Take it all away has a cost of equity of 10.45 percent, a pretax cost of debt of 5.21 percent, and a tax rate of 21 percent. The company's capital structure consists of 65 percent debt on a book value basis, but debt is 25 percent of the company's value on a market value basis. What is the company's weighted average cost of capital (WACC)?

Answer 1

The company's weighted average cost of capital (WACC) is calculated using the market value proportion of debt and equity, resulting in a WACC of 8.8665% by combining the cost of equity and the after-tax cost of debt.

Step-by-step explanation:

To calculate the company's weighted average cost of capital (WACC), we first need to adjust the cost of debt for taxes since the interest expense on debt can be deducted, which lowers the effective cost. Then we weight the cost of equity and the after-tax cost of debt according to the company's market value capital structure to find the WACC.

The after-tax cost of debt is calculated as the pretax cost of debt times (1 - tax rate), which is 5.21% times (1 - 0.21) = 4.116%. Since market values are more reflective of the company's current financial situation, we use the 25% debt and 75% equity market value weights for the calculations.

Now, we can calculate the WACC:
WACC = (Cost of Equity × Equity Proportion) + (After-Tax Cost of Debt × Debt Proportion)
WACC = (10.45% × 75%) + (4.116% × 25%)
WACC = 7.8375% + 1.029%
WACC = 8.8665%

Therefore, the WACC for 'Take it all away' is 8.8665%.