Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1.15. The company has a target debt-equity ratio of .65. The expected return on the market portfolio is 12 percent and Treasury bills currently yield 3.4 percent. The company has one bond issue outstanding that matures in 25 years, a par value of $1,000, and a coupon rate of 6.3 percent. The bond currently sells for $1,065. The corporate tax rate is 21 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

Now, let us calculate the cost of debt :

FV = $1000

PV = ($1065)

PMT = 6.3% * 1000

= $63

N = 25 YEARS

So, the I/Y is : 5.8%

The cost of equity of the company using the CAPM is :

Re = Rf + beta * (Rm - Rf)

= 3.4 % + 1.15 * (12% - 3.4%)

= 13.29%

So, the WACC is :

=weight of debt * after tax cost of debt + weight of equity * cost of equity

= 0.65/1.65 * 5.8% * (1 - 0.21) + 1/1.65 * 0.1329

= 0.0181 + 0.0805

= 9.86% ( rounded off to two decimal places)

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