Question

If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 1.3. WWI has a target debt/equity ratio of 0.4. The expected return on the market is 0.17, and Treasury bills are currently selling to yield 0.05. WWI one-year bonds (with a face value of $1,000) carry an annual coupon of 6% and are selling for $911.6. The corporate tax rate is 30%.(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 = 6%*1000 = 60
Price = 911.60
Number of Period = 1
YTM using excel formula=RATE(1,60,-911.60,1000)=16.28%
Before tax Cost of Debt = 16.28%

b. Beta Levered = Beta Unlevered * (1+(1-tax rate)*Debt/Equity = 1.3*(1+(1-30%)*0.4= 1.66
Cost of equity = Risk free Rate + Beta*(Market Return -Risk Free Rate) =5%+1.66*(17%-5%) = 24.92%

c. WACC = Weight of Equity * Cost of Equity+Weight of Debt*Cost of Debt*(1-Tax rate) =1/1.4*24.92%+0.4/1.4*16.28%*(1-30%)= 21.06%