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Luther Industries has an equity value of $450 million and $150 million in outstanding debt
Luther Industries has an equity value of $450 million and $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost of capital is 7%, and the corporate tax rate is 40%.
Luther's weighted average cost of capital is closest to:
Select one:
a.11.5%
b.10.8%
c. 9.8%
d.13.0%
Expert Solution
| Computation of Weighted Average Cost of Capital (WACC): | ||||
| Source of Capital | Amount | Weight | After Tax Cost of Capital | Weighted Tax Cost of Capital |
| Equity | 450.00 | 75% | 13% | 9.75% |
| Debt | 150.00 | 25% | 4.20% | 1.05% |
| 600.00 | WACC = | 10.80% | ||
| Computation of Weighted Average Cost of Capital (WACC): | ||||
| Source of Capital | Amount | Weight | After Tax Cost of Capital | Weighted Tax Cost of Capital |
| Equity | 450 | =450/600 | 0.13 | =75%*13% |
| Debt | 150 | =150/600 | =7%*(1-40%) | =25%*4.2% |
| =450+150 | WACC = | =9.75%+1.05% | ||
So, the correct option is B "10.80%. Weighted Average Cost of Capital is 10.80%.
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