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.)
a) Cost of debt at Dell = Pre-tax cost * ( 1 - tax rate )
= 6.3% * ( 1 - 38% )
Weight of debt = 709 / ( 709 + 65600 ) = 1.07%
Cost of Equity at Dell = Rf + Beta * Market risk premium
= 4.3% + 1.18 * 5.6%
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%
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