Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of .95. The company has a target debt-equity ratio of .65. The expected return on the market portfolio is 12 percent and Treasury bills currently yield 3.4 percent. The company has one bond issue outstanding that matures in 27 years, a par value of $2,000, and a coupon rate of 6.1 percent. The bond currently sells for $2,120. The corporate tax rate is 25 percent.

a. What is the company’s cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c. What is the company’s weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Cost % Market value capital structure 0.6061 WACC (Cost %*Weights) 8.76% Market value $ 0.61 =1/1.65 14.45% 2 Cost of equity 3 5 Debt (After tax cost) $ 0.3939 1.67% 4.25% =RATE(27,122,-2120,2000)*(1-25%) 0.39 =0.65/1.65 Total $ 1.00 1.0000 10 Weighted average cost of capital (WACC) 10.43% 11 RF + BUnlevered(RM -RF) 11.57% =3.3%+0.95*(12%-3.3%) 12 CAPM return 13 5.66% 14 Cost of debt 15 Cost of equity 14.45% -11.57%+(11.57%-5.66%)*0.65*(1-25%)

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