Question

Poly's Parrot Shops has found that its cost of common equity capital is 17 percent. It has 7-year maturity semiannual bonds outstanding with a price of $767.03 that have a coupon rate of 7 percent. The firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt. What is the after-tax weighted average cost of capital for Poly's, if it is subject to a 35 percent marginal tax rate? Round your final percentage answer to two decimal places.

A) 10.20%
B) 11.76%
C) 11.88%
D) 13.32%

Answer 1

The after-tax weighted average cost of capital (WACC) for Poly's is 10.20%.

Step-by-step explanation:

To calculate the after-tax weighted average cost of capital (WACC) for Poly's, we need to consider the cost of equity and the cost of debt. The cost of common equity is given as 17 percent, which is not affected by taxes. The cost of debt can be calculated by multiplying the coupon rate (7 percent) by (1 - tax rate) to account for the tax deductibility of interest payments. Therefore, the after-tax cost of debt is 4.55 percent (7% x (1 - 0.35)).

Next, we need to determine the weights of equity and debt in the capital structure. The market value of common shares is $120,000,000 and the market value of debt is $80,000,000. The total market value of the firm is $200,000,000. The weight of equity is $120,000,000 / $200,000,000 = 0.6 and the weight of debt is $80,000,000 / $200,000,000 = 0.4.

Finally, we can calculate the WACC by multiplying the weight of equity by the cost of equity and the weight of debt by the after-tax cost of debt, and then adding the two results together. WACC = (0.6 x 0.17) + (0.4 x 0.0455) = 0.102, or 10.20%.