Question

If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 1.1....

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 _____ %.

Homework Answers

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%

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