You are expected Sales to increase next year by 10% off of a base of $7,000 this

ID: 2731524 • Letter: Y

Question

You are expected Sales to increase next year by 10% off of a base of $7,000 this year.

Net Income this past year was $600.

Assets were 11,000 this year, and the

Sales/Assets ratio will remain constant next year.

Debt this past year was at 3,500, and the

Debt/Equity ratio will remain constant for the next year.

No debt will be retired and no stock will be retired.

No Dividends will be given out.

-Debt/Equity is 2.75

-Risk free rate is 3.5%

-Beta is 4.25

-Equity Risk Premium is 6.5%

-Cost of debt before tax adjustment is 6%

-corporate tax rate is 35%

1. What is the Weighted Average Cost of Capital (WACC)?

1. Ke = Rf + beta x equity risk premium

= 3.5% + 4.25 x 6.5%

= 31.125%

Kd = 6% x (1-0.35)

= 3.90%

Debt/equity = 2.75

Weight of debt = 2.75/3.75 = 0.73

Weight of equity = 1/3.75 = 0.27

WACC = 31.125% x 0.27 + 3.90% x 0.73

= 11.25%

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