Gnomes R Us is considering a new project. The company has a debt-equity ratio of

Question

Gnomes R Us is considering a new project. The company has a debt-equity ratio of .75. The company’s cost of equity is 14.9 percent, and the aftertax cost of debt is 8.2 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent. Requirement 1: What is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

WACC ????

Requirement 2: What discount rate should the firm use for the project? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

PROJECT DISCOUNT RATE ????

Explanation / Answer

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

WACC=.25*(14.9%)+.75(8.2%)

          =3.725%+6.15%

           =9.88%

discount rate should the firm use for the project=9.88%+2%=10.88%

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