Question

The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of 0.9. The Treasury bill rate is 4%, and the market risk premium is estimated at 6%. BCCI’s capital structure is 31% debt, paying an interest rate of 6%, and 69% equity. The debt sells at par. Buildwell pays tax at 21%.

a. What is BCCI’s cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

b. What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

c. If BCCI is presented with a normal 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?

Answer 1

As per CAPM, cost of Equity = Risk free rate + beta*Market risk premium

= 4% + 0.9*6%

= 9.4%

b.WACC = cost of debt*Weight of Debt + Cost of Equity*Weight of Equity

= 6%(1-21%)*31% + 9.4%*69%

= 7.9554%

c.Yes, should accept as Return is higher than WACC