NISM Certifications · NISM-Series-XV: Research Analyst · Valuation Principles
A firm has a cost of equity of 14%, a pre-tax cost of debt of 10%, a tax rate of 30%, and a target capital structure of 60% equity and 40% debt. What is its weighted average cost of capital (WACC)?
WACC is 11.2%. The after-tax cost of debt is 7% (10% times 0.70). Weighting 60% equity at 14% gives 8.4% and 40% debt at 7% gives 2.8%, which sum to 11.2%.
- A12.0%Correct
- B11.2%
- C13.2%
- D12.8%
Explanation
After-tax cost of debt = 10% x (1 - 0.30) = 7%. WACC = 0.60 x 14% + 0.40 x 7% = 8.4% + 2.8% = 11.2%. Hence the correct option is 11.2%, which is option index 1; the listed first option 12.0% is wrong.
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