Question

A large pet-food manufacturer is considering buying a small boutique cat food business to add to...

A large pet-food manufacturer is considering buying a small boutique cat food business to add to their portfolio of pet foods. The head of the finance division has approached you to conduct a financial analysis to determine the most the firm should pay for the cat food business.

The valuation of the cat-food business is based on cash flows of $180,500 per year over a five year period. The target business has the same risk as the firm’s overall operations. The cost of equity is 15 percent and the cost of debt is 3 percent on an after-tax basis. The firm’s capital structure consists of 10 million in equity and 8 million in debt.

What is the firm's WACC

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Answer #1
WACC is the weighted average cost of capital where the weights of capital structure is calculated so as to calculate the cost of capital of the company.
WACC = Weights of equity*Cost of equity + Weights of debt*Cost of debt
Calculation of weight of equity and debt
Value of capital Weights
Equity $10 0.555556
Debt $8 0.444444
$18
WACC = 0.555556*0.15 + 0.444444*0.03
WACC 9.67%
The firm's WACC is 9.67%
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