A firm finances with 60% equity at 12% cost and 40% debt with 6% pre-tax cost and 30% tax rate. Compute the weighted average cost of capital (WACC).

• A. 7.50%
• B. 8.28%
• C. 8.88%
• D. 9.50%

Answer: (C)

WACC blends the cost of equity and the after-tax cost of debt in proportion to how the firm is financed. Use this formula: WACC = (equity weight × cost of equity) + (debt weight × after-tax cost of debt). The after-tax cost of debt is Rd × (1 − Tc).

Here, equity weight is 0.60 and cost of equity is 0.12, contributing 0.60 × 0.12 = 0.072 (7.2%). Debt weight is 0.40 and pretax debt cost is 0.06, so after tax the cost of debt is 0.06 × (1 − 0.30) = 0.042 (4.2%), contributing 0.40 × 0.042 = 0.0168 (1.68%). Adding these gives 0.072 + 0.0168 = 0.0888, i.e., 8.88%.

So the weighted average cost of capital is 8.88%.