ExpertHard1 markMultiple Choice
CPA · Question 12 · Area I: Business Analysis
Calculate the Weighted Average Cost of Capital (WACC) given the following:<br/>- Target Capital Structure: 60% Equity, 40% Debt<br/>- Cost of Equity: 12%<br/>- Pre-tax Cost of Debt: 8%<br/>- Corporate Tax Rate: 25%
Calculate the Weighted Average Cost of Capital (WACC) given the following:<br/>- Target Capital Structure: 60% Equity, 40% Debt<br/>- Cost of Equity: 12%<br/>- Pre-tax Cost of Debt: 8%<br/>- Corporate Tax Rate: 25%
Answer options:
A.
10.4%
B.
8.8%
C.
9.6%
D.
10.0%
How to approach this question
Apply WACC formula. Crucial step: Adjust cost of debt for taxes: Kd(after-tax) = Kd(pre-tax) * (1 - Tax Rate).
Full Answer
C.9.6%✓ Correct
After-tax cost of debt = 8% * (1 - 0.25) = 6%. Weighted Cost = (60% * 12%) + (40% * 6%) = 7.2% + 2.4% = 9.6%.
Common mistakes
Forgetting the tax shield on debt; using book values instead of target weights (if provided).
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