Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1.10. The company has a target debt-equity ratio of .75. The expected return on the market portfolio is 11 percent and Treasury bills currently yield 3.6 percent. The company has one bond issue outstanding that matures in 29 years, a par value of $2,000, and a coupon rate of 6.3 percent. The bond currently sells for $2,100. The corporate tax rate is 22 percent.

  

a.	What is the company’s cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	What is the company’s weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

a.Cost of debt. %

b.Cost of equity. %

c.WACC. %

Answer 1

Given Beta=1.1,

Debt-Equity ratio = 0.75

Risk free rate is government bonds rate , here it is the treasury bills rate= 3.6%

expected return on the market portfolio = 11 %

Par value or face value=2000, premium value=2100

coupon rate=6.3%, Tax rate=22%

Cost of debt can be calculate using YTM(yield to maturity formula)

Coupon rate= 6.3%2000 =126

YTM or Cost of debt= 5.94%

B ) Cost of Equity can be done in two way 1)CAPM 2) DDM model

since the dividends aren't given, We use the CAPM model.

Expected return = Risk Free Rate + Beta x (Expected market return - Risk free rate)

NOTE: converting all percentages to decimals because Beta will not be expressed in percentages.

Cost of equity = 0.036 + 1.1 x [0.11-0.036]

COST OF EQUITY = 0.1174 or 11.74%

C) Weighted average cost of capital= (Equity/Debt * Ke) + (Debt/Equity) * Kd * (1 – Tax rate)+ (P/A) * Kp

1. Ke = Cost of Equity
2. Kd = Cost of Debt
3. Tax Rate = Corporate Tax Rate
4. Kp= cost of preference share

No to find weights from D/E ratio it states that 3 parts of debt equals to 4 parts of equity.

Weight of debt= 3/(3+4)=3/7=0.42

Weight of equity=4/7=0.57

WACC=(0.57*0.1174)+(0.42*(1-0.22)*0.0594)

WACC= 8.88% is the percentage of amount the company has to finance its assets to pay to share holders.