Cost of Capital Problems – WACC & Component Cost

Calculating WACC is simple multiplication. The trick is getting the "Weights" right.

Problem 1: Calculate WACC

Question: An MNC "Global Ltd" has the following capital structure:

1. Equity: $ 60 Million (Cost Ke = 15%).
2. Debt: $ 40 Million (Interest Rate = 10%).
3. Tax Rate: 30%. Calculate Weighted Average Cost of Capital (WACC).

Solution:

Step 1: Calculate Cost of Debt (Kd) (Post-Tax) Kd = Interest * (1 - Tax Rate) Kd = 10% * (1 - 0.30) = 7%

Step 2: Table Calculation

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• Answer: The MNC's WACC is 11.8%.

Problem 2: Foreign Loan Impact

Question:

• Domestic Borrowing Rate: 12%.
• Foreign Borrowing Rate (USD): 6%.
• Expected Depreciation of Rupee: 4%.
• Which is cheaper?

Solution:

• Effective Cost of Foreign Loan = Interest Rate + Depreciation.
• Effective Cost = 6% + 4% = 10%.
• Comparison: 10% (Foreign) < 12% (Domestic).
• Decision: Borrow in Foreign Currency.

Exam Notes: Tips

1. Weights: Always use Market Value weights if given. If not, use Book Value.
2. Tax: Never forget to multiply Debt Cost by (1-t). Equity Cost is NOT adjusted for tax.
3. Effective Cost: Approx formula Rd + Depreciation is sufficient for exams. (Precise form is (1+Rd)(1+Dep) - 1, but usually ignored at B.Com level).

Quiz Time! 🎯

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