Question

How do you determine the average cost of capital before taxation?

How do you determine the average cost of capital after taxation?

Own Capital R500 000

Longterm loan R150 000 15% p.a.

Bank overdraft R50 000 12% p.a.

Trade payables R80 000

Taxation rate 28% p.a.

After taxation rate of return required on capital 20% p.a.

Answer 1

Sources	Amount ($)	Proportion (Note 1)	Before tax cost	Proportionate cost of capital before tax
Own capital	500,000.00	0.7143	20%	0.14
Long term loan	150,000.00	0.2143	15%	0.03
Bank overdraft	50,000.00	0.0714	12%	0.01
	700,000.00	Average cost of capital before tax		0.18

Thus, average cost of capital before tax is 18%.

Sources	Amount ($)	Proportion (A/B)	Before tax cost	Tax rate	After tax cost {Cost x (1- tax rate)}	proportionate cost of capital (After tax)
Own capital	500,000.00	0.7143	20%	N.A.	0.20	0.14
Long term loan	150,000.00	0.2143	15%	28%	0.11	0.02
Bank overdraft	50,000.00	0.0714	12%	28%	0.09	0.01
	700,000.00	Average cost of capital after tax				0.17

Thus, average cost of capital after tax is 17%

Note 1:

Portions have been calculated
Sources	Amount ($)	Proportions have been calculated
Own capital	500,000.00	500000/700000
Long term loan	150,000.00	150000/700000
Bank overdraft	50,000.00	50000/700000
	700,000.00