Question

Problem 13-21 : Question Help Your company has two divisions: One division sells software and the other division sells computers through a direct sales channel, primarily taking orders over the internet. You have decided that Dell Computer is very similar to your computer division, in terms of both risk and financing. You go online and find the following information: Dell's beta is 1.22, the risk-free rate is 4.5%, its market value of equity is $66.1 billion, and it has $690 million worth of debt with a yield to maturity of 6.3%. Your tax rate is 35% and you use a market risk premium of 5.2% in your WACC estimates. a. What is an estimate of the WACC for your computer sales division? b. If your overall company WACC is 11.2% and the computer sales division represents 35% of the value of your firm, what is an estimate of the WACC for your software division? a. The weighted average cost of capital for your computer sales division is %. (Round to two decimal places.)

Answer 1

1Cost of equity= Rf+ Beta*Rp

= 4.5%+1.22*5.2%

= 10.844%

The cost of debt= YTM*(1-tax rate)

= 6.3*(1-35%)

= 4.095%

WACC = Sum of Weights* the after-tax cost

= 10.844%*(66100/(66100+690))+4.095%*(690/(66100+690))

= 10.7743%

=10.77%

2: Let the WACC of software = W

Hence Company WACC = 35%*10.77%+(1-35%)*W

11.2%= 3.77%+0.65W

W = 11.43%