A firm has the current liabilities and equity financing on its balance sheet shown below. The firm has taxable income that puts it in a 35% federal tax bracket. Compute the after-tax firm’s weighted average cost of capital.
Source | Amount | Interest/RoR |
Short-term loan | $6,000 | 7.5% |
Long-term loan | $21,000 | 4.5% |
Retained Earnings | $35,000 | 17.0% |
Common stock | $38,000 | 2.0% |
Weighted average cost of capital = Long term debt*Cost of debt + Cost of equity*Weight of Equity + cost of retained earnings*Weight of retained earnings
= 4.5%(1-35%)*21,000/(21,000+35,000+38,000)+ 17%*35,000/94,000 + 20%*38,000/94,000
= 15.07%
Note: Interest paid on debt is tax deductible
Current liabilities are not a part of capital structure
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