Question

Colt Manufacturing has two? divisions: 1)? pistols; and? 2) rifles. Betas for the two divisions have been determined to be beta

?(pistol)equals=0.40.4

and beta

?(rifle)equals=0.90.9.

The current? risk-free rate of return is

4.54.5?%,

and the expected market rate of return is

9.5 %9.5%.

The? after-tax cost of debt for Colt is

33?%.

The pistol? division's financial proportions are

37.537.5?%

debt and

62.562.5?%

?equity, and the rifle? division's are

47.547.5?%

debt and

52.552.5?%

equity.

a. What is the pistol? division's WACC?

b.??What is the rifle? division's WACC?

Answer 1

Beta of pistol = 0.4

Beta of rifle = 0.9

Risk free rate = 4.5%

Required return of pistol = 4.5% + 0.4 * (9.5% - 4.5%)

Required return of pistol = 6.50%

Required return of rifel = 4.5% + 0.9 * (9.5% - 4.5%)

Required return of rifel = 9%

After tax cost of debt = 33%

Pistol division WACC = 6.5% * 0.625 + 33% *0.375

Pistol division WACC = 16.4375%

Rifel division WACC = 9% * 0.525 + 33% *0.475

Rifel division WACC = 6.29%