A company is evaluating a project. What is the appropriate discount rate that it should use if its marginal tax rate is 34%, its capital structure is…

The appropriate discount rate for a project that reflects the company's capital structure is the Weighted Average Cost of Capital (WACC). The WACC formula is: WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × Cost of Debt × (1 - Tax Rate)). The cost of debt is adjusted for taxes because interest payments are tax-deductible, creating a "tax shield."

Using the provided data:

WACC = (0.40 × 0.10) + (0.60 × 0.04 × (1 - 0.34))

WACC = 0.04 + (0.024 × 0.66)

WACC = 0.04 + 0.01584

WACC = 0.05584 or 5.58%

A. 5.04% is incorrect. This result is obtained by mistakenly applying the tax shield to the cost of equity instead of the cost of debt.

B. 5.30% is incorrect. This figure does not correspond to a standard calculation or a common conceptual error in the WACC formula; it is likely a distractor.

D. 6.40% is incorrect. This is the pre-tax WACC, calculated by ignoring the tax-deductibility of interest on debt, which understates the value of the tax shield.

1. Brealey

R. A.

Myers

S. C.

& Allen

F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education. Chapter 17

"Valuation and Capital Budgeting for the Levered Firm

" discusses the WACC formula and its application. The formula is presented as: WACC = (D/V) (1 - Tc) rD + (E/V) rE.

2. Damodaran

A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3rd ed.). John Wiley & Sons. Chapter 8

"Estimating the Cost of Capital

" provides a detailed breakdown of the WACC calculation. The formula and its components (cost of equity

after-tax cost of debt

and weights) are explained on pages 193-195.

3. Massachusetts Institute of Technology (MIT) OpenCourseWare. (2009). 15.401 Finance Theory I

Fall 2008. Lecture Notes

"Lecture 9: Capital Budgeting and Valuation with Leverage." Section 3

"The Weighted Average Cost of Capital (WACC) Method

" explicitly details the formula: rWACC = (E/V)rE + (D/V)rD(1-τc). Available at: https://ocw.mit.edu/courses/15-401-finance-theory-i-fall-2008/resources/mit15401f08lec09/