Question

What is the WACC for Bacon Signs Inc, if the after-tax cost of long-term debt is 6.3% and the before tax cost of equity is 10.4%?

a. 8.02%

b. 8.91%

c. 9.58%

d. Without a corporate tax rate, we cannot answer this question as written.

Answer 1

Weighted average cost of capital, wacc is the sum of the, products of weights and the cost of the various capital available to the company.

wacc = [ (weight of debt * after-tax cost of debt) + (weight of common equity capital * cost of equity) + (cost pf preferred equity * weight of preferred equity in the capital structure) ]

Here,

wacc = [ wtD * Kd * (1-t)] + wtE * Ke

where

• Kd * (1-t) = after-tax cost of debt = 6.30%
• Before tax cost of equity, Ke = 10.40%

Assuming different weights for the Debt and Equity, calculating wacc as in the below table:

Wt of Debt	Wt of Equity	wtD * Kd * (1-t)	wtE * Ke	wacc
0	1	0.00%	10.40%	10.40%
0.1	0.9	0.63%	9.36%	9.99%
0.2	0.8	1.26%	8.32%	9.58%
0.3	0.7	1.89%	7.28%	9.17%
0.4	0.6	2.52%	6.24%	8.76%
0.5	0.5	3.15%	5.20%	8.35%
0.6	0.4	3.78%	4.16%	7.94%
0.7	0.3	4.41%	3.12%	7.53%
0.8	0.2	5.04%	2.08%	7.12%
0.9	0.1	5.67%	1.04%	6.71%
1	0	6.30%	0.00%	6.30%

With the capital structure of 20% Debt and 80% Common Equity, wacc = 9.58%

Answer: option (c)