Question

You work for HydroTech, a large manufacturer of high-pressure industrial water pumps. The firm specializes in natural disaster services, ranging from pumps that draw water from lakes, ponds, and streams in droughtstricken areas to pumps that remove high water volumes in flooded areas. You report directly to the CFO. Your boss has asked you to calculate the WACC in preparation for an executive retreat. Too bad you're not invited, as water pumps and skiing are on the agenda in Sun Valley, Idaho. At least you have an analyst on hand to gather the following required information:

1) The risk-free rate of interest, in this case, the yield of the ten-year government bond, which is 3%.

2) Hydrotech’s:

a. Market capitalization (its market value of equity) is $100 million.

b. CAPM beta, 1.2.

c. Total book value of debt outstanding, is $50 million.

d. Cash, is $10 million.

3) The cost of debt (using the quoted yields on HydroTech's outstanding bond issues) which is 5%. With this information in hand, you are now prepared to undertake the analysis.

Case Questions

1) Calculate HydroTech's net debt.

2) Compute HydroTech's equity and (net) debt weights based on the market value of equity and the book value of net debt.

3) Calculate the cost of equity capital using the CAPM, assuming a market risk premium of 5%.

4) Using a tax rate of 35%, calculate HydroTech's effective cost of debt capital.

5) Calculate HT's WACC. (10 points) 6) When is it appropriate to use this WACC to evaluate a new project?

Answer 1