Question

Please Answer A-B

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 1.21, the risk-free rate is 4.7%, its market value of equity is $66.9 billion, and it has $690 million worth of debt with a yield to maturity of 6.2%. Your tax rate is 38% and you use a market risk premium of 5.8% in your WACC estimates. a. What is an estimate of the WACC for your computer sales division? b. If your overall company WACC is 12.8% and the computer sales division represents 40% of the value of your firm, what is an estimate of the WACC for your software division? Note: Assume that the firm will always be able to utilize its full interest tax shield. a. What is an estimate of the WACC for your computer sales division? %. (Round to two decimal places.) The weighted average cost of capital for your computer sales division is

Answer 1

Given,

Dell's beta = 1.21

Risk free rate = 4.7%

Cost of debt = 6.2%

Tax rate = 38% or 0.38

Market risk premium = 5.8%

Solution :-

Cost of equity for Dell = Rf tab (market disk Bemium) Where, Rf - disk-free date b = beta of Dell Now, Cost of equity for Dell = 4.7% + 1.21 (5.8%) = 4.7% + 7.018% = 11.718% Weight of Dell's equity (We) = Equity Equity & Det 66.9 = 66.9+0.690 66.9 67.59 - 0.98979

weight of Dell's Debt (ud) = 1 - weight of Dell's equity = 1 - 0.98979 = 0.00021 W ACC for Dell = (ke (We) + (Kd) (Wa) where, Ke = Cost of equity. Kd = Cost of debt We e weight of equity We = weight of debt

After tax Cost of debt (ka). = Cost of debt (l- tax rate) 6.2% (1-038) 2 6.2% (0.62) = 3.844% Now, W ACC for del = (17.718% (0.98979) + (3.844% 6.0l021) = 11.59835922% + 8 3924 727 O. 03924724 E 11.64 % Since, Dell Computers is very similar to your computer division, WACC o for dell equals to WACC for your Computer sales division. So, w ace for Computer sales division would be 11.64%

weight Sales of Computer division (Wo) = 40% g 0.40 weight of - 1-0.40 software division (Ws) = 0.60 Now, Overall company WACC = (We WACC of Computer sales division) + (Ws) (WACC of software division) 12.8% = (0.40) (11.64%) + (0.60) (WACC of L Software division) 12.8% = 4.656% +(0.60) (WACC of software division) 12.8% -4.656% = (0.60 ( WACC of software division) 8. 144% =(0.60) (WACC of software division)

8.144% 0.60 – WACC of software division 13.57% = WACC of software division Thus, Estimate of the WACC for your software division is 13.57%