Question

Take It All Away has a cost of equity of 10.72 percent, a pretax cost of debt of 5.39 percent, and a tax rate of 35 percent. The company's capital structure consists of 74 percent debt on a book value basis, but debt is 34 percent of the company's value on a market value basis. What is the company's WACC?

Answer 1

To calculate Take It All Away's WACC, adjust the cost of debt for taxes and apply the market value proportions of debt and equity to determine the weighted costs. Then sum these costs using the WACC formula.

Step-by-step explanation:

The student is asking how to calculate the Weighted Average Cost of Capital (WACC) for a company named Take It All Away, which has different costs of capital for equity and debt, as well as two different measures for its capital structure--book value basis and market value basis.

To calculate the company's WACC, we first adjust the company's cost of debt to reflect the tax shield benefit by multiplying it with (1 - tax rate), which in this case is (1 - 0.35). Then, we use the market value proportions of debt and equity to find the weighted costs, where the market value of debt is 34% and equity is 66%. The WACC is the sum of these weighted costs.

WACC Formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) where E = market value of equity, D = market value of debt, V = E + D, Re = cost of equity, Rd = cost of debt, and Tc = tax rate. Applying the given values, the WACC for Take It All Away can be calculated.