Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1. The company has a target debt–equity ratio of .2. The expected return on the market portfolio is 10 percent, and Treasury bills currently yield 4.3 percent. The company has one bond issue outstanding that matures in 20 years and has a coupon rate of 7.6 percent. The bond currently sells for $1,110. The corporate tax rate is 34 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

a) Cost of Debt
Face Value	$1,000.00
Coupon Rate = 7.6%/2	3.80%
Coupon Payment	$38.00
Period = 20 x 2	40
Present Value	$1,110.00
YTM = Rate(20,76,-1110,1000)	3.30%
Cost of Debt = 3.06% x2	6.60%
b)
Cost of equity R0 = RF + ?Unlevered(RM ? RF)
Cost of Equity = Rf + Beta x (RM - RF)
Cost of equity = 4.3% + 1 x(10% - 4.3%)	10.00%
Cost of levered equity=RS = R0 + (B/S)(R0 ? RB)(1 ? TC)
RS = 10% + (.2) x (10% ? 6.60%)x (1 ? 34%)	10.45%
C)
Weight of Equity = 1/(1+.2)	83.33%
Weight of Debt = 1 - 83.33%	16.67%
WACC = 83.33% x 10.45% + 16.67% x 6.60% x (1-34%)	9.43%