Question

15. CoffeeStop primarily sells coffee. It recently introduced a premium coffee-flavored liquor (BF Liquors). Suppose the firm faces a tax rate of 38% and collects the following information. If it plans to finance 12% of the new liquor-focused division with debt and the rest with equity, what WACC should it use for its liquor division? Assume a cost of debt of 4.7%, a risk-free rate of 2.5%, and a market risk premium of 6.5%. CoffeeStop BF Liquors Beta 0.61 0.23 % Equity 94% 88% % Debt 6% 12% Note: Assume that the firm will always be able to utilize its full interest tax shield. The weighted average cost of capital is %. (Round to two decimal places.)

Answer 1

	Beta	Equity	Debt	Cost of equit	cost of debt	WACC
Coffeeshop	0.61	94%	6%	6.465%	2.9140%	6.252%
BF liq	0.23	88%	12%	3.995%	2.9140%	3.865%
	Cost of equity		Riskfreef + beta (Market risk premium)
	Coffeeshop		2.5 + (.61) 6.5 =		6.465
	BF liq		2.5 + (.23) 6.5 =		3.995
	Cost of debt	Less tax @ 38%	After tax cost of debt
	4.7000	1.7860	2.9140
	4.7000	1.7860	2.9140
	WACC = Weigt of equit x cost of equity + weight of debt x cost of debt
	Coffeeshop	6.252%
	BF liq	3.865%