ExpertMedium1 markMultiple Choice
CPA · Question 09 · Area I: Business Analysis
Omega Corp. has the following capital structure:<br/>- Debt: $4,000,000 (Market Value), Yield to Maturity 6%<br/>- Equity: $6,000,000 (Market Value), Cost of Equity 12%<br/><br/>The corporate tax rate is 25%. What is Omega's Weighted Average Cost of Capital (WACC)?
Omega Corp. has the following capital structure:<br/>- Debt: $4,000,000 (Market Value), Yield to Maturity 6%<br/>- Equity: $6,000,000 (Market Value), Cost of Equity 12%<br/><br/>The corporate tax rate is 25%. What is Omega's Weighted Average Cost of Capital (WACC)?
Answer options:
A.
9.6%
B.
8.4%
C.
9.0%
D.
9.3%
How to approach this question
Calculate weights based on market values. Apply tax shield to cost of debt. WACC = (Wd * Rd * (1-t)) + (We * Re).
Full Answer
C.9.0%✓ Correct
C
1. Weights: Debt = 4/10 = 40%; Equity = 6/10 = 60%.<br/>2. After-tax Cost of Debt: 6% x (1 - 0.25) = 4.5%.<br/>3. WACC = (Weight of Debt x After-tax Cost) + (Weight of Equity x Cost of Equity)<br/> = (0.40 x 4.5%) + (0.60 x 12%)<br/> = 1.8% + 7.2% = 9.0%.
Common mistakes
Using book values if given (though not given here); forgetting tax shield on debt.
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