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 7%. BCCI’s capital structure is 28% debt, paying an interest rate of 5%, and 72% 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.) c. If BCCI is presented with a project with an internal rate of return of 12%, should it accept the project if it has the same level of risk as the current firm?

Answer 1

Answer a:

Cost of equity capital = Risk free rate + Beta * Market risk premium

BCCI’s cost of equity capital = 4% + 0.9 * 7% = 10.30%

BCCI’s cost of equity capital = 10.30%

Answer b:

WACC = Cost of equity * Weight of equity + Cost of debt * (1 - Tax rate) * Weight of debt

BCCI’s WACC = 10.30% * 72% + 5% * (1 - 40%) * 28% = 8.256%

BCCI’s WACC = 8.26%

Answer c:

BCCI’s WACC = 8.26%

Internal rate of return (IRR) of the project = 12%

Since IRR of the project is greater than BCCI's cost of capital (WACC), it should accept the project.