# Income Tax Problem Solution Chapter 4

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```					Problem 11.2 Trident's cost of capital

Calculate the cost of equity, debt, and WACC.

Values used
Original assumptions in Chapter                                              in Chapter               New Values
Trident's beta, β                                                                  1.20                     1.30
Cost of debt, before tax, kd                                                     8.00%                   7.000%
Risk-free rate of interest, krf                                                  5.00%                   4.000%
Corporate income tax rate, t                                                    35.00%                  30.000%
General return on market portfolio, km                                          15.00%                   9.000%
Optimal capital structure:
Proportion of debt, D/V                                                          40%                       50%
Proportion of equity, E/V                                                        60%                       50%

a) Trident's cost of equity                                                     17.000%                  10.500%
ke = krf + ( km - krf ) β

b) Trident's cost of debt, after tax                                             5.200%                   4.900%
kd x ( 1 - t )

c) Trident's weighted average cost of capital                                 12.2800%                   7.7000%
WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ]

One of the most interesting aspects of capital costs is how they have been trending downward in recent years as a
result of lower interest rates, lower equity market returns, and in some countries, lower tax rates. As a result of
the general decline in business and economic performance, many firms have been reducing their debt levels -- if
possible -- in roder to reduce their debt service requirements. But, one factor which has not necessarily fallen in
value is the beta of the individaul firm. Here Trident's cost of capital has fallen dramatically, but its beta is
actually higher than before due to more market volatility.

```
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