Question

WACC Comparables - 2 If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 1.3. WWI has a target debt/equity ratio of 0.4. The expected return on the market is 0.08, and Treasury bills are currently selling to yield 0.05. WWI one-year bonds (with a face value of $1,000) carry an annual coupon of 7% and are selling for $906.96. The corporate tax rate is 39%.(Round your answers to 2 decimal places before the percentage sign. (e. 10.23%)) a. WWI's before-tax cost of debt is 17.98 %. b. Wwl's cost of equity is D % c. WWI's weighted average cost of capital is %.

Answer 1

$1,000 x 7% [$93.04- $906.96] $70.00 a) One year's interest payment on bonds Add: Change in bond price in one year $93.04 $163.04 Total cost incurred on bond for one year $906.96 Bond's current selling price [$163.04/ $906.96] Bond's before-tax cost of debt 17.98% b) Using CAPM, Cost of equity % Risk-free rate [Beta x (Market return Risk-free rate)] Risk-free rate 0.05 Beta 1.3 Market return 0.08 0.05 [1.3 x (0.08 - 0.05)] Cost of equity 8.90%

c) Weighted average cost of capital = Weighted after-tax cost of debt Weighted cost of equity Bond's before-tax cost of debt 17.98% [Ref: Part-(a)] Tax rate 39% Bond's after-tax cost of debt [17.98% x (1-39%] 10.9657% [0.4 (1+0.4) Weight of debt Weighted after-tax cost of debt Cost of equity 28.57% [10.9657% x 28.57%] 3.13% [Ref: Part-(b) [1/(1+0.4) [8.9% x 71.43%] 8.90% Weight of debt Weighted cost of equity 71.43% 6.36% Weighted average cost of capital (WACC) 9.49% (3.13%+6.36%)