IAI Actuarial Core Principles · Business Finance · Personal and corporate taxation
Kaveri Industries has a tax rate of 30%. It has equity with market value Rs 600 crore and cost of equity 14%, and permanent debt with market value Rs 400 crore at a pre-tax cost of 10%. Using the market-value weighted average cost of capital with debt cost adjusted for tax, what is the WACC?
The WACC is 11.2%. Debt cost after tax is 7%, from 10% times 0.7. Weighting by market values of 60% equity and 40% debt gives 0.6 x 14% plus 0.4 x 7%, which equals 11.2%. Ignoring tax would give 12.4%.
- A12.0%
- B10.6%
- C11.2%Correct
- D12.4%
- 11.0%
Explanation
Weights are 0.6 equity and 0.4 debt. After-tax debt cost = 10% x 0.7 = 7%. WACC = 0.6 x 14 + 0.4 x 7 = 8.4 + 2.8 = 11.2%. Using the pre-tax 10% gives 12.4%, which ignores the tax shield.
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