Taggart Transcontinental currently has no debt and an equity cost of capital of 16%. Suppose

that Taggart decides to increase its leverage and maintain a market debt - to-value ratio of 1/3.

Suppose Taggartʹs debt cost of capital is 9% and its corporate tax rate is 35%. Assuming that

Taggartʹs pre-tax WACC remains constant, then with the addition of leverage its effective

after-tax WACC will be closest to:

A) 13.0% B) 16.0% C) 15.0% D) 12.9%

Question

Bennett Ward

Business

29 November, 08:42

Taggart Transcontinental currently has no debt and an equity cost of capital of 16%. Suppose

that Taggart decides to increase its leverage and maintain a market debt - to-value ratio of 1/3.

Suppose Taggartʹs debt cost of capital is 9% and its corporate tax rate is 35%. Assuming that

Taggartʹs pre-tax WACC remains constant, then with the addition of leverage its effective

after-tax WACC will be closest to:

A) 13.0% B) 16.0% C) 15.0% D) 12.9%

+2

Answers (1)

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Vincent · Answer 1

D) 12.9%

Explanation:

WACC formula;

WACC = wE*rE + wD*rD (1-tax)

whereby,

wE = weight of equity = 2/3 or 66.67%

rE = cost of equity = 16%

wD = weight of debt = 1/3 or 33.33%

rD = pretax cost of debt = 9%

WACC = (0.6667*0.16) + [0.3333*0.09 (1-0.35) ]

= 0.1067 + 0.0195

= 0.1262 or 12.62%

Therefore, the after-tax WACC will be closest to 12.9%