Question

The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of.9. The Treasury bill rate is 4%, and the market risk premium is estimated at 6%. BCCI's capital structure is 29% debt, paying an interest rate of 10%, and 71% equity. The debt sells at par. Buildwell pays tax at 40%. a. What is BCCI's cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.) Cost of equity capital % b. What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) WACC % c. If BCCI is presented with a project with an internal rate of return of 10%, should it accept the project if it has the same level of risk as the current firm? Yes Ο Νο

Answer 1

Answer to Part a.
Cost of Equity = Risk Free Rate + Beta * Market Risk Premium
Cost of Equity = 4% + 0.9 * 6%
Cost of Equity = 9.4%

Answer to Part b.
Before Tax Cost of Debt = 10%
After Tax Cost of Debt = 10% * (1 – 0.40)
After Tax Cost of Debt = 6%

WACC = (Weight of Debt * After Tax Cost of Debt) + (Weight of Equity * Cost of Equity)
WACC = (0.29 * 6%) + (0.71 * 9.4%)
WACC = 8.41%

Answer to Part c.
Yes.
The BCCI should accept the project as WACC of the project is more than Internal rate of return.