Question

If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 1.1. WWI has a target debt/equity ratio of 1. The expected return on the market is 0.18, and Treasury bills are currently selling to yield 0.07. WWI one-year bonds (with a face value of $1,000) carry an annual coupon of 12% and are selling for $971.92. The corporate tax rate is 40%.(Round your answers to 2 decimal places before the percentage sign. (e.g., 10.23%))

a.	WWI’s before-tax cost of debt is _____ %.
b.	WWI’s cost of equity is ______ %.
c.	WWI’s weighted average cost of capital is _____ %.

Answer 1

a. Par Value = 1000
Coupon = 12%*1000 = 120
Price = 971.92
Number of Period = 1
YTM using excel formula=RATE(1,120,-971.92,1000)=15.24%
Before tax Cost of Debt = 15.24%

b. Beta Levered = Beta Unlevered * (1+(1-tax rate)*Debt/Equity = 1.1*(1+(1-40%)*1= 1.76
Cost of equity = Risk free Rate + Beta*(Market Return -Risk Free Rate) =7%+1.76*(18%-7%) = 26.36%


c. WACC = Weight of Equity * Cost of Equity+Weight of Debt*Cost of Debt*(1-Tax rate) =1/2*26.36%+1/2*15.24%*(1-40%)= 17.75%