Suppose your firm has decided to use a divisional WACC approach to analyze proje

Question

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.55, 0.9, 1.2, and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1 and a current risk-free rate of 6.8 percent) is 13.7 percent and the after-tax yield on the company's bonds is 10.3 percent.

What will the WACCs be for each division?

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.55, 0.9, 1.2, and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1 and a current risk-free rate of 6.8 percent) is 13.7 percent and the after-tax yield on the company's bonds is 10.3 percent.

Explanation / Answer

Cost of the Debt 10.3 Cost of Equity of A=(6.8+0.55*(13.7-6.8))*0.5+0.5*10.3 10.45 Cost of Equity of B=(6.8+0.9*(13.7-6.8))*0.5+0.5*10.4 11.71 Cost of Equity of C=(6.8+1.2*(13.7-6.8))*0.5+0.5*10.5 12.79 Cost of Equity of D=(6.8+1.5*(13.7-6.8))*0.5+0.5*10.6 13.88

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