Blues, Inc. is an MNC located in the U.S. Blues would like to estimate its weigh

Question

Blues, Inc. is an MNC located in the U.S. Blues would like to estimate its weighted average cost of capital. On average, bonds issued by Blues yield 5.42%. Currently, T-bill rates are 0.32% (0.0032 in decimals). Furthermore, Blues' stock has a beta of 1.34, and the return on the Wilshire 5000 stock index (a measure of the return on the market) is expected to be 11.50%. Blues has a debt-to-equity ratio (D/E) of 47% (or 0.47 in decimals). If Blues is in the 35% tax bracket, what is its (a) aftertax cost of debt, (b) cost of equity (ke), and (c) weighted average cost of capital (kc)? NOTE: Round to at least 4 decimal places in all intermediate calculations. Give your final answers for (a), (b), and (c) in percent, rounded to 2 decimal places.

Explanation / Answer

(a) After tax cost of debt = 5.42% * (1 - 35%)

= 3.52%

(b) Cost of equity = 0.32% + 1.34 * (11.50% - 0.32%)

= 15.30%

(c) Debt ratio = 1 - [1 / (1 + D/E)]

= 1 - 1 / (1 + 0.47)

= 0.32

Weighted average cost of capital = 3.52% * 0.32 + 15.30% * 0.68

= 11.53%

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