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WACC and Capital Gains Tax

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12-12A (Weighted average cost of capital). The target capital structure for QM Industries is 40 percent common stock, 10 percent preferred stock, and 50 percent debt. If the cost of equity for the firm is 18 percent, the cost of preferred stock is 10 percent, the before-tax cost of debt is 8 percent, and the firm's tax rate is 35 percent, what is QM's weighted average cost of capital?

10-1B: (Capital gains tax). The R. T. Kleinman Corporation is considering selling one of its old assembly machines. The machine, purchased for $40,000 five years ago, had an expected life of 10 years and an expected salvage value of zero. Assume Kleinman uses simplified straight-line depreciation, creating depreciation of $4,000 per year,and could sell this old machine for $45,000. Also assume a 34 percent marginal tax rate.

A) What would be the taxes associated with this sale?
B) If the old machine were sold for $40,000, what would be the taxes associated with this sale?
C) If the old machine were sold for $20,000, what would be the taxes associated with this sale?
D) If the old machine were sold for $17,000, what would be the taxes associated with this sale?

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Solution Summary

Calculates WACC and capital gains tax.

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12-12A
(Weighted average cost of capital) The target capital structure for QM Industries is 40 percent common stock, 10 percent preferred stock, and 50 percent debt. If the cost of equity for the firm is 18 percent, the cost of preferred stock is 10 percent, the before-tax cost of debt is 8 percent, and the firm's tax rate is 35 percent, what is QM's weighted average cost of capital?

Step 1: Calculate the after tax cost of debt

Marginal Tax rate T = 35% (Corporate Tax Rate)
Pre tax cost of debt= kd= 8.00%
After tax cost of debt= kd(1-T)= 5.200% =(100% -35.%)*8.%

Step 2: Calculate the weighted average cost of capital

WACC=proportion of debt x after tax cost of debt + proportion of common stock x cost of common stock + proportion of ...

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