ACCA FM · Chapter 12 · Question 9 of 9
Under Modigliani and Miller's theory with corporate tax, an ungeared company has a cost of equity of 10%. If it introduces debt so that debt makes up 30% of the total market value of the company, and the tax rate is 25%, what is its new WACC?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) 9.25%
Explanation
MM with tax: WACCg = Keu x (1 - T x Vd/(Vd + Ve)) = 10% x (1 - 0.25 x 0.3) = 10% x 0.925 = 9.25%. WACC falls as gearing increases because of the value of the tax shield on debt. 10.00% is the MM no-tax result.
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