Question

A firm has a total market value of $10 million while its debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the tax rate is 21 percent? (Round to the nearest decimal place).

Multiple Choice

• 13.0 percent

• 12.2 percent

• 8.8 percent

• 10.4 percent

Answer 1

B. 12.2 percent

Weighted average cost of capital = (Weight of equity * Cost of equity) + [Weight of debt * Before-tax cost of debt(1 - Tax)]

Weighted average cost of capital = (0.6 * 0.15) + [0.4 * 0.10(1 - 0.21)

Weighted average cost of capital = 0.122 or 12.2 percent