Question

Rumolt Motors has 24 million shares outstanding with a price of $ 13 per share. In​ addition, Rumolt has issued bonds with a total current market value of $ 368 million. Suppose​ Rumolt's equity cost of capital is 9 %​, and its debt cost of capital is 5 %. a. What is​ Rumolt's pretax weighted average cost of​ capital? b. If​ Rumolt's corporate tax rate is 21 %​, what is its​ after-tax weighted average cost of​ capital? a. What is​ Rumolt's pretax weighted average cost of​ capital? ​Rumolt's pretax weighted average cost of capital is 6.83​%. ​(Round to two decimal​ places.) b. If​ Rumolt's corporate tax rate is 21 %​, what is its​ after-tax weighted average cost of​ capital? ​Rumolt's after-tax weighted average cost of capital is 6.04​%. ​ (Round to two deci

Answer 1

Answer:

WACC without taxes         =   6.84% (rounding up to two decimals)

WACC with a tax rate of 21%=   6.27% (rounding up two decimals)

Explanation:

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

To calculate WACC we need to know the weight's for equity adn debt:

Equity: 24,000,000 x 13 = 312,000,000

Debt 368,000,000

Value: 680,000,000

Debt weight's 368M/680M = 0.458823529

Equity weight's 312M/680M =0.541176471

Now we have he weights can calculate the WACC

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

Ke 0.09

Equity weight 0.458823529

Kd 0.05

Debt Weight 0.541176471

t 0 (as this is a pretax, tax is zero)

$WACC = 0.09(0.458823529411765) + 0.05(1-0)(0.541176470588235)$

WACC 6.83529%

then, for b we are asked for a 21% tax rate, everything else remains unchanged:

if t = 21% then:

t 0.21

$WACC = 0.09(0.458823529411765) + 0.05(1-0.21)(0.541176470588235)$

WACC 6.26706%