week 12 10. The Basic Biotech Corporation wants to determine its weighted averag

Question

week 12

10. The Basic Biotech Corporation wants to determine its weighted
average cost of capital. Its target capital structure weights are 50 percent
long-term debt and 50 percent common equity. The before-tax cost of
debt is estimated to be 10 percent, and the company is in the 30 percent
tax bracket. The current risk-free interest rate is 8 percent on Treasury
bills. The after-tax cost of common equity capital is 14.5 percent. Calcu-
late the after-tax weighted average cost of capital.

Explanation / Answer

cost of debt after tax, r(D) * 10 * (1-T) = 10 *(1 - 0.30) = 7% cost of equity r(E) = 14.5% weight of equity, W(E) = 0.5 weight of debt, W(D) = 0.5 (data of risk free rate is superfluous in this case) WACC = W(E)*r(E) + W(D)*r(D) (after tax rate) => = 0.5*14.5 + 0.5*7 => = 10.75 % (ANSWER)

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