Omega Corp. has the following capital structure: - Debt: $4,000,000 (Market Value), Yield to Maturity 6% - Equity: $6,000,000 (Market Value), Cost of Equity 12% The corporate tax rate is 25%. What is Omega's Weighted Average Cost of Capital (WACC)?

Answer options:

9.6%

8.4%

9.0%

9.3%

How to approach this question

Calculate weights based on market values. Apply tax shield to cost of debt. WACC = (Wd * Rd * (1-t)) + (We * Re).

Full Answer

C.9.0%✓ Correct

1. Weights: Debt = 4/10 = 40%; Equity = 6/10 = 60%. 2. After-tax Cost of Debt: 6% x (1 - 0.25) = 4.5%. 3. WACC = (Weight of Debt x After-tax Cost) + (Weight of Equity x Cost of Equity) = (0.40 x 4.5%) + (0.60 x 12%) = 1.8% + 7.2% = 9.0%.

Common mistakes

Using book values if given (though not given here); forgetting tax shield on debt.

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Omega Corp. has the following capital structure:<br/>- Debt: $4,000,000 (Market Value), Yield to Maturity 6%<br/>- Equity: $6,000,000 (Market Value), Cost of Equity 12%<br/><br/>The corporate tax rate is 25%. What is Omega's Weighted Average Cost of Capital (WACC)?

How to approach this question

Full Answer

Common mistakes

Practice the full CPA BAR Practice Exam 4

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