A company’s capital structure is as follows: Equity ₹5 crore at a cost of 12% per annum, Preference shares ₹2 crore at a dividend rate of 10%, and Long‑term loan ₹3 crore at an interest rate of 9% per annum. The corporate tax rate is 30%. Calculate the weighted average cost of capital (WACC) of the company (in %).
Answer
9.89%
The correct answer is 9.89% — State the final WACC as 9.89%.
Step-by-step solution
- Calculate the total capital (V): V = Equity + Preference + Debt = 5 + 2 + 3 = ₹10 crore.
- Find the weight of each component: Weight of Equity (E/V) = 5/10 = 0.5; Weight of Preference (P/V) = 2/10 = 0.2; Weight of Debt (D/V) = 3/10 = 0.3.
- Determine the after‑tax cost of debt: Rd(1‑T) = 9% × (1‑0.30) = 9% × 0.70 = 6.3% because interest is tax‑deductible.
- Apply the WACC formula: WACC = (E/V)·Re + (P/V)·Rp + (D/V)·Rd(1‑T).
- Substitute the values: WACC = 0.5·12% + 0.2·10% + 0.3·6.3% = 6% + 2% + 1.89% = 9.89%.
- State the final WACC as 9.89%.
Common mistake: Forgetting to adjust the cost of debt for tax, which leads to an over‑estimated WACC.
Concept tested: Weighted average cost of capital
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