Question

A firm has a capital structure with $100 million in equity and $100 million of debt. The cost of equity capital is 15% 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. Group of answer choices

Answer 1

The weighted average cost of capital of the firm is 10.125%

Step-by-step explanation:

The computation of the weighted average cost of capital is shown below:

= Cost of equity × weight of equity + cost of debt × (1 - tax rate) × weight of debt

= 15% × $100 ÷ ($100 + $100) + 7% × (1 - 0.25) × $100 ÷ ($100 + $100)

= 15% × 0.5 + 7% × 0.75 × 0.5

= 7.5% + 2.625%

= 10.125%

Hence, the weighted average cost of capital of the firm is 10.125%

We simply applied the above formula