Question

Your company has two​ divisions: One division sells software and the other division sells computers through a direct sales​ channel, primarily taking orders over the internet. You have decided that Dell Computer is very similar to your computer​ division, in terms of both risk and financing. You go online and find the following​ information: Dell's beta is 1.18​, the​ risk-free rate is 4.3 %​, its market value of equity is $ 65.6 ​billion, and it has $ 709 million worth of debt with a yield to maturity of 6.3 %. Your tax rate is 38 % and you use a market risk premium of 5.6 % in your WACC estimates. a. What is an estimate of the WACC for your computer sales​ division? b. If your overall company WACC is 11.9 % and the computer sales division represents 35 % of the value of your​ firm, what is an estimate of the WACC for your software​ division? ​Note: Assume that the firm will always be able to utilize its full interest tax shield. a. What is an estimate of the WACC for your computer sales​ division? The weighted average cost of capital for your computer sales division is nothing​%. ​ (Round to two decimal​ places.)

Answer 1

Answer :

a) Cost of debt at Dell = Pre-tax cost * ( 1 - tax rate )

= 6.3% * ( 1 - 38% )

= 3.91%

Weight of debt = 709 / ( 709 + 65600 ) = 1.07%

Cost of Equity at Dell = Rf + Beta * Market risk premium

= 4.3% + 1.18 * 5.6%

= 10.91%

Weight of Equity = 65600 / ( 709 + 65600 ) = 98.93%

WACC = ( 1.07% * 3.91% ) + ( 98.93% * 10.91% )

= 0.04% + 10.79%

WACC = 10.83%

b) WACC for overall firm is also weighted (by value) average of two divisions of firm.

WACC for firm = WACC for Computer sales division * % of value of Computer sales division + WACC for Software sales division * % of value of Software sales division

11.9% = ( 10.83% * 35% ) + ( WACC for Software sales division * 65% )

WACC for Software sales division = 12.48%