Richard works for a firm that is expanding into a completely new line of busines

ID: 2698213 • Letter: R

Question

Richard works for a firm that is expanding

into a completely new line of business. He has been asked to

determine an appropriate WACC for an average risk project In the

expansion division. Richard finds two publicly traded stand-alone

firms that produce the same products as his Ã‚ new

division. The average of the two firms betas is

1.25. Further, he determines that the expected return of the market

portfolio is 13.00% and the risk free rate of return is 4.00%

Richards firms finances 50% of its projects with equity and 50%

with debt, and has a before tax cost of debt of 9% and a corporate

tax rate of 30%. What is the WACC for the new line of business?

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Cost of equity is 4.0 +1.25(13-4)= 15.25

Cost of debt is (after tax) 9(1-.3)= 6.3

Since the project is financed 50-50 we have 15.25*.5 +6.3*.5= 10.775

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