Question

Your company has two? divisions: One division sells software and the other division sells computers through a direct sales? channel, primarily taking orders over the internet. You have decided that Dell Computer is very similar to your computer? division, in terms of both risk and financing. You go online and find the following? information: Dell's beta is 1.23?, the? risk-free rate is 4.7%?, its market value of equity is $67.9 ?billion, and it has $704 million worth of debt with a yield to maturity of 6.1%. Your tax rate is 35% and you use a market risk premium of 5.7% in your WACC estimates. a. What is an estimate of the WACC for your computer sales? division? b. If your overall company WACC is 12.5% and the computer sales division represents 44% of the value of your? firm, what is an estimate of the WACC for your software? division?

Answer 1

2 division - total

computer division - 56%

sales division - 44 %

since computer division of our company is equal to the entire dell, then

WACC of dell = weight of equity * cost of equity + weight of debt 8 cost of debt (1-tax rate)

cost of equity (CAPM) = risk-free rate + beta (risk premium)

= 4.7 + 1.23 (5.7)

= 4.7+ 7.011

= 11.711 %

cost of debt = 704 million * 6.1%

= 704000000 * 6.1%

= 42944000 $

WACC of Dell = .99 (.11711) + .01 (.061) *(1-0.35)

= .116 + 0.00061 ( .65)

= .116+ 0.0003965

= .1163965

WACC of dell = 11.64 %

WACC of our company = 12.5%

total capital of our company

56 % computer division = 67900+ 704 = 68604 million $

44% sales divison =( 68604/.56)* .44

= 53903 million $

total capital 56 % computer divison = 68604

44 % software division = 53903

total capital = 68604+ 53903

= 122507 million

weight of equity = (68604/122507)*100

= .56

weight of debt = (53903/122507) * 100

= .44

WACC for software division = total company WACC * sales division percentage

= 12.5% * .44

= 5.5 %

WACC for software division = 5.5 %