Answer: 4.7%.

## Explanation To calculate the Weighted Average Cost of Capital (WACC), we use the formula: \[ \text{WACC} = \frac{E}{E+D} \times r_e + \frac{D}{E+D} \times r_d \times (1 - t) \] Where: - \( E \) = Market value of equity - \( D \) = Market value of debt - \( r_e \) = Cost of equity - \( r_d \) = Pre-tax cost of debt - \( t \) = Marginal tax rate **Step 1: Calculate total market value of capital** \[ E = \$500 \text{ million} \] \[ D = \$1,000 \text{ million} \] \[ E + D = \$500 + \$1,000 = \$1,500 \text{ million} \] **Step 2: Calculate weights** \[ w_e = \frac{E}{E+D} = \frac{500}{1,500} = 0.3333 \] \[ w_d = \frac{D}{E+D} = \frac{1,000}{1,500} = 0.6667 \] **Step 3: Calculate after-tax cost of debt** \[ r_d \times (1 - t) = 4\% \times (1 - 0.30) = 4\% \times 0.70 = 2.8\% \] **Step 4: Calculate WACC** \[ \text{WACC} = (0.3333 \times 6\%) + (0.6667 \times 2.8\%) \] \[ = (0.3333 \times 0.06) + (0.6667 \times 0.028) \] \[ = 0.02 + 0.018667 \] \[ = 0.038667 \] \[ = 3.8667\% \] **Step 5: Compare with options** - 3.6% is too low - 3.9% is closest to 3.8667% - 4.7% is too high Therefore, the WACC is closest to **3.9%**. **Key Points:** 1. WACC uses **market values** (not book values) for weights 2. The cost of debt is tax-adjusted since interest is tax-deductible 3. The formula weights each component by its proportion in the capital structure

Author: LeetQuiz .