What is the WACC for Bacon Signs Inc, if the after-tax cost of long-term debt is 6.3% and the before tax cost of equity is 10.4%?
a. 8.02%
b. 8.91%
c. 9.58%
d. Without a corporate tax rate, we cannot answer this question as written.
Weighted average cost of capital, wacc is the sum of the, products of weights and the cost of the various capital available to the company.
wacc = [ (weight of debt * after-tax cost of debt) + (weight of common equity capital * cost of equity) + (cost pf preferred equity * weight of preferred equity in the capital structure) ]
Here,
wacc = [ wtD * Kd * (1-t)] + wtE * Ke
where
Assuming different weights for the Debt and Equity, calculating wacc as in the below table:
Wt of Debt | Wt of Equity | wtD * Kd * (1-t) | wtE * Ke | wacc |
0 | 1 | 0.00% | 10.40% | 10.40% |
0.1 | 0.9 | 0.63% | 9.36% | 9.99% |
0.2 | 0.8 | 1.26% | 8.32% | 9.58% |
0.3 | 0.7 | 1.89% | 7.28% | 9.17% |
0.4 | 0.6 | 2.52% | 6.24% | 8.76% |
0.5 | 0.5 | 3.15% | 5.20% | 8.35% |
0.6 | 0.4 | 3.78% | 4.16% | 7.94% |
0.7 | 0.3 | 4.41% | 3.12% | 7.53% |
0.8 | 0.2 | 5.04% | 2.08% | 7.12% |
0.9 | 0.1 | 5.67% | 1.04% | 6.71% |
1 | 0 | 6.30% | 0.00% | 6.30% |
With the capital structure of 20% Debt and 80% Common Equity, wacc = 9.58%
Answer: option (c)
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