The weighted average cost of capital (WACC) can be calculated as

WACC= E/V ke + D/V Kd (1-t)

whereEis the market value of equity,Dis the market value of debt,V=E+D,k_eis the cost of equity,k_dis the cost of debt andtis the tax rate.

Briefly explain whyk_eis not multiplied by (1 -t) in this WACC?

(b)Using a corporate tax rate of 30%, calculate Spyware's after tax WACC based on the following information.

Spyware Ltd is financed through debt and equity. Currently, a Spyware share sells for $10.50 and 1 million of these shares have been issued. Analysis indicates that the appropriate Beta for a Spyware share is 1.25. Further, the risk-free rate is 5% p.a. and the expected market return is 13% p.a. Spyware has also issued 100,000 bonds. Each of these bonds has a face value of $100, three years to maturity, pay an annual coupon of 10% and currently trade for $105.154. Finally, Spyware has a bank loan with a balance of $2,000,000. The interest rate on this loan is 10% p.a.

(c)Outline one reason why the WACC from (b) may not be the appropriate WACC for evaluating all of Spyware's capital investment decisions.