Jay Barrone is an independent performance management consultant and operates Quantifi Inc. He is currently on contract with Barron Bilge Corporation to evaluate the effectiveness of the firm’s management and operations. Summary of market and firm data: Cost of Debt Capital 7.5% Cost of Equity Capital 14% Debt to Total Capital 60% Equity to Total Capital 40% EBIT $20 million EAT $10 million Total Assets $100 million Question: Jay calculates the WACC for BBC. The WACC for BBC is closest to: a) 8.3% b) 10.1% c) 8.0% d) 10.2%

a

i dont get this part… Debt to Total Capital 60% Equity to Total Capital 40% what do yo u mean equity to total capital?

Assets. ^

my calc is closer to - D?

It depends on if that is after tax cost of debt. If you assume that it is than the answer is B.

I agree on A. They hide the tax rate in EBIT and EAT. So I guess that is the trick here.

why am I getting 8.1875% ?

EDIT: to sponge It isn’t. You have to take EBIT, back out interest expense and then compare it to EAT to determine you tax rate. Then calculate the after-tax cost of debt and plug into WACC.

I get close to A if I assume it isn’t the after tax cost of debt, but not exactly that number.

I get a marginal tax rate of 35.48%, is that correct?

That’s what I got. My answer wasn’t exact.

tax calc: Debt 100 x 60% = 60 60 X 7.5% = 4.5 20 - 4.5 = 15.5 Since EAT is 10, that means tax component is 5.5 therefore 5.5/15.5 = 35.5%

so WACC = 7.5 (1-.355) + 14*.4 = approx 10.4 I guess closer to D

Yes. 1 - 10/ (20-60 * 0.075) = 35.48 % .

Right, so WACC equation would give you: .6(.075)(1-.3568) + .4(.14) = .085 or 8.5% Just pisses me off when they don’t give you an exact answer as one of the choices (assuming I’ve done that correctly).

moregreat Wrote: ------------------------------------------------------- > so WACC = 7.5 (1-.355) + 14*.4 = approx 10.4 > I guess closer to D You forgot to weight the average by the capital makeup.

Sponge_Bob_CFA Wrote: ------------------------------------------------------- > Right, so WACC equation would give you: > > .6(.075)(1-.3568) + .4(.14) = .085 or 8.5% > > Just pisses me off when they don’t give you an > exact answer as one of the choices (assuming I’ve > done that correctly). That is what I got sponge. Maybe we are doing something wrong.

moregreat Wrote: ------------------------------------------------------- > so WACC = 7.5 (1-.355) + 14*.4 = approx 10.4 > I guess closer to D You forgot to apply the .6 debt weighting to the debt portion of the calculation.

Interest expense = .075 * (.6*100mm) = $4.5MM $20MM - $4.5MM = $15.50MM EBT $15.50 - 10MM = $5.5 MM Taxes $5.5/15.50 = 35.48% tax rate WACC = .6(.075)(1-.3548) + .4(.14) = .02934 + .056 = 8.53% closest is A