[Anonymous]

A company has a tax rate of 40%. Information for the company is as follows:

Amount // Before-tax Cost

Mortgage bonds $1,200,000 7.2%

Common stock $3,800,000 10%

What is the weighted average cost of capital (WACC)?

A. 9.33%.

B. 8.64%.

C. 0.08%.

D. 8.60%

Answer: B. 8.64%. The calculation is ($1.2M / $5M) (.072) (1 – .4) + ($3.8M / $5M) (.1).

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Why do you factor tax rate in the bonds calculation but not in the common stock calculation?

[Anonymous]

Because the bonds are debt and bear interest: But interest expense reduces taxable income. Entity pays (1-T)% of the interest, but the government “pays” (i.e. subsidizes) the tax rate%.

Conversely, common stock bears no interest. Basically, all you have to consider is the cost of capital given in the question, and weight it appropriately.

[Anonymous]

Because the bonds are debt and bear interest: But interest expense reduces taxable income. Entity pays (1-T)% of the interest, but the government “pays” (i.e. subsidizes) the tax rate%.

Conversely, common stock bears no interest. Basically, all you have to consider is the cost of capital given in the question, and weight it appropriately.

[Jennifer241]

Tax incentive for bonds, and not for stock.

AUD - Jan 9,13 Pass
REG - Aug 30,13 Pass
BEC - Oct 26,13 Pass
FAR - Dec 4,13 Pass

Licensed CPA in the state of Oregon

[Jennifer241]

Tax incentive for bonds, and not for stock.

AUD - Jan 9,13 Pass
REG - Aug 30,13 Pass
BEC - Oct 26,13 Pass
FAR - Dec 4,13 Pass

Licensed CPA in the state of Oregon

[mcarras]

For WACC problems, the tax rate is taken into account for debt only because of the interest.

[mcarras]

For WACC problems, the tax rate is taken into account for debt only because of the interest.

[Author]

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