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CS Professional · Strategic Management and Corporate Finance · Sources of Corporate Funding

A company has equity share capital of Rs 60 lakh with cost of equity 15% and 10% debentures of Rs 40 lakh. The tax rate is 25%. What is its weighted average cost of capital (WACC), using book value weights?

The WACC is 12.00%. The after-tax cost of debt is 7.5 percent, that is 10 percent times 0.75. Weighting equity at 60 percent with 15 percent cost and debt at 40 percent with 7.5 percent cost gives 9 plus 3, which is 12 percent.

  1. A12.50%
  2. B16.50%
  3. C13.50%Correct
  4. D12.00%

Explanation

Post-tax cost of debt = 10% x (1 - 0.25) = 7.5%. Weights are 0.6 and 0.4. WACC = 0.6 x 15 + 0.4 x 7.5 = 9 + 3 = 12.0%. Check: 12.00 is the result, so the correct option must be 12.00%. Using the pre-tax debt cost gives 13%, which is the key error.

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