ExpertMedium2 marksShort Answer
ACCA · Question 09 · Estimating the Cost of Capital
'AquaPure', a water desalination utility, has a market value of equity of $10 million and a market value of debt of $5 million. The cost of equity is 12% and the pre-tax cost of debt is 8%. The corporate tax rate is 25%.
Calculate AquaPure's Weighted Average Cost of Capital (WACC).
(Enter your answer as a percentage to one decimal place, e.g., 10.5. Do not include the % sign)
'AquaPure', a water desalination utility, has a market value of equity of $10 million and a market value of debt of $5 million. The cost of equity is 12% and the pre-tax cost of debt is 8%. The corporate tax rate is 25%.
Calculate AquaPure's Weighted Average Cost of Capital (WACC).
(Enter your answer as a percentage to one decimal place, e.g., 10.5. Do not include the % sign)
How to approach this question
Calculate the after-tax cost of debt. Then weight the cost of equity and after-tax cost of debt by their respective market value proportions.
Full Answer
1. Calculate after-tax cost of debt: 8% × (1 - 0.25) = 6%.
2. Total market value (V) = $10m (Equity) + $5m (Debt) = $15m.
3. Weight of Equity = 10/15. Weight of Debt = 5/15.
4. WACC = (10/15 × 12%) + (5/15 × 6%) = 8% + 2% = 10.0%.
Common mistakes
Forgetting to apply the tax shield to the cost of debt, which would result in a WACC of 10.67%.
Practice the full ACCA FM — Financial Management Practice Exam 3
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