Question

The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of 0.9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCI’s capital structure is 38% debt, paying an interest rate of 7%, and 62% equity. The debt sells at par. Buildwell pays tax at 40%.

a. What is BCCI’s cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.

b. What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

a

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 0.9 * (8)

Cost of equity% = 11.2

b

Weight of equity = 1-D/A

Weight of equity = 1-0.38

W(E)=0.62

Weight of debt = D/A

Weight of debt = 0.38

W(D)=0.38

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 7*(1-0.4)

= 4.2

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.2*0.38+11.2*0.62

WACC =8.54%