Question

Rumolt Motors has 41 million shares outstanding with a price of $39 per share. In​ addition, Rumolt has issued bonds with a total current market value of $1,071 million. Suppose​ Rumolt's equity cost of capital is 11%​, and its debt cost of capital is 6%.

a. What is​ Rumolt's pretax weighted average cost of​ capital?

b. If​ Rumolt's corporate tax rate is 38%​, what is its​ after-tax weighted average cost of​ capital?

Answer 1

- Total Market Value of equity = Share Price*No of shares outstanding = $39*41 million

Total Market Value of equity = $1599 million

Total Market Value of Debt = $1071 million

Total Capital Structure = $1599 million + $1071 million = $2670 million

a). Calculating Pre-tax weighted average cost of​ capital(WACC):-

WACC= (Weight of Debt)(Cost of Debt) + (Weight of Equity)(Cost of Equity)

WACC = ($1071 million/$2670 million)(6%) + ($1599 million/$2670 million)(11%)

WACC = 2.4067% + 6.5876%

WACC = 8.99%

So, Rumolt's pretax weighted average cost of​ capital is 8.99%

b).  Calculating After-tax weighted average cost of​ capital(WACC):-

WACC= (Weight of Debt)(Cost of Debt)(1-Tax rate) + (Weight of Equity)(Cost of Equity)

WACC = ($1071 million/$2670 million)(6%)(1-0.38) + ($1599 million/$2670 million)(11%)

WACC = 1.4922 + 6.5876%

WACC = 8.08%

So, Rumolt's After-tax weighted average cost of​ capital is 8.08%

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