Question

If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 1.4. WWI has a target debt/equity ratio of 2. The expected return on the market is 0.08, and Treasury bills are currently selling to yield 0.03. WWI one-year bonds (with a face value of $1,000) carry an annual coupon of 10% and are selling for $934.8. The corporate tax rate is 36%.(Round your answers to 2 decimal places before the percentage sign. (e.g., 10.23%))

a. WWI’s before-tax cost of debt is _________ %.

b. WWI’s cost of equity is ________ %.

c. WWI’s weighted average cost of capital is ____________ %.

Answer 1

a) FV = 1000, PV = -934.8, N = 1, PMT = 100

use rate function in Excel

pretax cost of debt = 17.67% 22

b) levered beta = 1.4*(1 + 2*(1-036)) = 3.192

cost of equity = 3% + 5%*3.192 = 18.96%

c)

	Amount	weight	cost	weight*cost
equity	1.00	0.3333	18.9600%	0.0632
debt	2.00	0.6667	11.3102%	0.0754

after tax cost of debt has been mentioned above

WACC = 13.86%