Question

Branson works for a firm that is expanding into a completely new line of business. He has been asked to determine an appropriate WACC for an averageminusrisk project in the expansion division. Branson finds two publicly traded standminusalone firms that produce the same products as his new division. The average of the two​ firm's betas is 1.40.​ Further, he determines that the expected return on the market portfolio is​ 11.00% and the riskminusfree rate of return is​ 3.00%. Branson's firm finances​ 70% of its projects with equity and​ 30% with​ debt, and has a beforeminustax cost of debt of​ 8% and a corporate tax rate of​ 20%. What is the WACC for the new line of​ business?

Answer 1

the WACC for the new line of​ business is 14.80%

Step-by-step explanation:

Weighted Average Cost of Capital is the minimum return that a project must offer before it can be accepted.

Capital Source Weight Cost Total

Equity 70% 18.40% 12,88%

Debt 30% 6.40% 1,92%

Total 100% 14.80%

Calculation of Cost of Equity

The details available allow us to use the Capital Asset Pricing Model to find the Cost of Equity.

Cost of Equity = Risk Free Rate + Beta × Risk Premium

=3.00%+ 1.40×11.00%

= 18.40%

Calculation of Cost of Debt

We use the after tax Cost of Debt as follows :

Cost of Debt = Market Interest Rate × (1-tax rate)

= 8% × (1-0.20)

= 6.40%

Answer 2

11.86%

Step-by-step explanation:

First we need to calculate the return on equity(Re).

re = rf + B(rm-rf)

re = 0.03 + (1.4)*(0.11-0.03) => 0.142 or 14.2%.

Now the formula for WACC is,

WACC = (re * %of Equity) + ((rd * %of Debt)(1-tax rate))

Hence this is calculated as,

WACC = (0.70*0.142)+((0.30*0.08(1-0.20))

WACC = 11.86% or 0.1186.

Hope this helps. Goodluck.