ExpertEasy2 marksShort Answer
ACCA · Question 06 · Estimating the Cost of Capital
Section A
ServicePro Co has a market value of equity of $60 million and a market value of debt of $40 million. The cost of equity is 12% and the pre-tax cost of debt is 6%. The corporation tax rate is 25%.
Calculate the Weighted Average Cost of Capital (WACC) for ServicePro Co. (Enter your answer as a percentage to one decimal place, e.g., 8.5)
Section A
ServicePro Co has a market value of equity of $60 million and a market value of debt of $40 million. The cost of equity is 12% and the pre-tax cost of debt is 6%. The corporation tax rate is 25%.
Calculate the Weighted Average Cost of Capital (WACC) for ServicePro Co. (Enter your answer as a percentage to one decimal place, e.g., 8.5)
How to approach this question
Use the WACC formula: WACC = [Ve / (Ve + Vd)] * Ke + [Vd / (Ve + Vd)] * Kd * (1 - t).
Full Answer
Total Market Value (V) = Ve + Vd = $60m + $40m = $100m.
Weight of Equity = 60/100 = 0.60
Weight of Debt = 40/100 = 0.40
After-tax cost of debt = 6% * (1 - 0.25) = 4.5%
WACC = (0.60 * 12%) + (0.40 * 4.5%) = 7.2% + 1.8% = 9.0%.
Common mistakes
Forgetting to multiply the cost of debt by (1-t).
Practice the full ACCA FM — Financial Management Practice Exam 2
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