Question

Solid Construction Company has the following amounts of interest-bearing debt and common equity capital: Financing Dollar Interest Cost of Source Amount Rate Equity Short-Term Loan $300,000 10% Long-Term Loan $100,000 18% Equity Capital $600,000 22% Solid Construction is in the 30 percent average tax bracket. The after-tax weighted average cost of capital (WACC) for Solid is (a) 16.56%. (b) 16.84%. € 17.12%. (d) 18.84%. € None of the above.

Answer 1

Short term loan = $300000, Cost of short term loan = 10%, Long term loan = 100000, Cost of long term loan = 18%

Equity = 600000, Cost of equity = 22%

Total capital = Short term loan + Long term loan + Equity = 300000 + 100000 + 600000 = 1000000

Tax rate = 30%

Weight of short term loan in total capital = Short term loan / Total capital = 300000 / 1000000 = 30%

Weight of Long term loan in total capital = Long term loan / Total capital = 100000 / 1000000 = 10%

Weight of equity in total capital = Equity / Total capital = 600000 / 1000000 = 60%

After tax WACC = Weight of short term loan in total capital x Cost of short term loan x (1 - tax rate) + Weight of long term loan in total capital x Cost of long term loan x (1 - tax rate) + Weight of equity in total capital x Cost of equity

After tax WACC = 30% x 10% x (1-30%) + 10% x 18% x (1-30%) + 60% x 22%

After tax WACC = 30% x 10% x 70% + 10% x 18% x 70% + 60% x 22% = 2.10% + 1.26% + 13.20% = 16.56%

Hence After tax weighted average cost of capital = 16.56%

Answer: a) 16.56%