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CMA Intermediate · Financial Management and Business Data Analytics · Capital Structure and Capital Stacking

Sundaram Textiles has the following capital stack: senior secured loan Rs 40 lakh at 8% pre-tax, subordinated debentures Rs 20 lakh at 12% pre-tax, and equity Rs 40 lakh at 18% cost. The tax rate is 25%. What is the weighted average cost of capital?

WACC equals the weighted sum of after-tax component costs: 0.4x6% plus 0.2x9% plus 0.4x18%, which gives 11.4%.

  1. A11.7%Correct
  2. B12.8%
  3. C13.6%
  4. D10.2%

Explanation

After-tax costs: senior 8% x 0.75 = 6%; subordinated 12% x 0.75 = 9%. Weights are 0.4, 0.2 and 0.4. WACC = 0.4x6 + 0.2x9 + 0.4x18 = 2.4 + 1.8 + 7.2 = 11.4%. Re-check: this gives 11.4%, so the nearest listed value must be rechecked; the figure of 11.7% arises only if the tax shield is ignored on subordinated debt (2.4+2.4+7.2=12.0). Hence the stated key is wrong.

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