The Nutrex Corporation wants to calculate its weighed average cost of capital. I

Question

The Nutrex Corporation wants to calculate its weighed average cost of capital. It's target capital structure weights are 40% long term debt and 60% common equity. The before tax cost of debt is estimated to be 10% and the company is in the 40% tax bracket. The current risk free interest rate is 8% on treasury bills. The expected return on the market is 13% and the firms beta is 1.8.

A. What is Nutrex's cost of debt?
B. Estimate Nutrex's expected return on common equity usins the security line.
C. Calculate the after tax weighed average cost of capital

Explanation / Answer

a) cost of debt =( weight of debt)*(1-tax)*(before tax cost of debt) weight of debt = 40% = 0.4 tax = 40% = 0.4 before tax cost of debt = 10% = 0.1 cost of debt = 0.4*(1-0.4)*0.1 = 0.024 = 2.4% b)expected return on equity =risk free return +(beta)x(market return - risk free return) = 0.08 + 1.8(0.13-0.08) = 0.17 = 17% c)after tax weighed average cost of capital = (cost of debt) + (weight of equity)x(return on equity ) = 0.024 + 0.6*0.17 = 0.126 = 12.6%

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