Question

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm...

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.7, 1.0, 1.4, and 1.6, respectively. Assume all current and future projects will be financed with 60 debt and 40 equity, the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 3 percent) is 12 percent and the after-tax yield on the company’s bonds is 10 percent. What will the WACCs be for each division

Homework Answers

Answer #1

Working :

Cost of equity =Rf+[beta *market risk premium]

12 = 3+ [1*MRP]

12-3 = MRP

MRP = 9%

Cost of equity :

A= 3+[.7*9]

   =3 + 6.3

    =9.3%

B= 3+ [1*9]

= 3+9

= 12%

C= 3+ [1.4*9]

= 3+ 12.6

= 15.6%

D= 3+[1.6*9]

= 3+ 14.4

= 17.4%

Now

WACC =[After tax cost of debt *weight of debt]+[cost of equity *weight of equity]

A =[10*.60]+[9.3*.40]

     = 6+ 3.72

      = 9.72%

B= [10**.60]+[12*.40]

= 6 + 4.8

   =10.8%

C= [10*.60]+[15.6*.40]

= 6 + 6.24

= 12.24%

D= [10*.60]+[17.4*.40]

= 6 + 6.96

= 12.96%

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