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ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation

Kovar Inc. has a market value of equity of $60m and debt of $40m. The risk-free rate is 4%, the equity beta is 1.2 and the market risk premium is 5%. Pre-tax cost of debt is 6% and the tax rate is 25%. What is Kovar's WACC, to two decimal places?

Cost of equity is 4% + 1.2 × 5% = 10%, after-tax cost of debt is 4.5%, and weighting 60:40 gives 7.80%.

  1. A7.50%
  2. B8.28%Correct
  3. C8.40%
  4. D9.48%

Explanation

Ke = 4% + 1.2 × 5% = 10%. After-tax Kd = 6% × 0.75 = 4.5%. WACC = 0.6 × 10% + 0.4 × 4.5% = 6.0% + 1.8% = 7.80%. Recheck: this gives 7.80%, so option 8.28% is wrong and no listed value matches.

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