Question

A firm has a capital structure with $30 million in equity and $90 million of debt. The cost of equity capital is 11% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 25%, compute the weighted average cost of capital of the firm.

Answer 1

Answer: 6.69%

Step-by-step explanation:

The weighted average cost of capital is calculated as:

= (Weight of equity * Cost of equity) + (Weight of debt * after-tax cost of debt)

Weight of equity:

= 30 million / (30 + 90 million)

= 25%

Weight of debt:

= 100% - Weight of equity

= 100% - 25%

= 75%

WACC = (25% * 11%) + (75% * 7% *(1 - 25% tax rate))

= 2.75% + 3.9375%

= 6.69%