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Calculation of company cost of capital and WACC

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1) A company is 40% financed by risk- free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is 0.5. What is the company cost of capital? What is the after- tax WACC, assuming that the company pays tax at a 35% rate?

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The first step in calculating the after-tax WACC is calculating the cost of each component of the WACC.

The WACC is equal to the cost of each component multiplied by its weight (proportion of financing provided by that component).

First, we will calculate the after-tax cost of debt. This is equal to the interest rate (which is the cost) multiplied by 1 minus the tax rate. ...

Solution Summary

The question provides the percentage of debt in the company's capital structure, the interest rate, the market risk premium, the tax rate, and the company's common stock beta. This information is used to calculate the company cost of capital and the after-tax weighted average cost of capital (WACC).

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After looking at the project and talking with some people that have been around the organization for many years, you recognize that the 10% cost of capital is not reflective of the company's current cost of capital. The head of treasury has assured you that the company can raise debt at 7% in today's market and that if the firm was not going to use the US$4M to invest in the machine for the production plant, it would be invested in some short-term securities yielding 5%.

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