If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1.15.

Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1.15. The company has a target debt–equity ratio of .6. The expected return on the market portfolio is 10 percent, and Treasury bills currently yield 3.6 percent. The company has one bond issue outstanding that matures in 20 years and has a coupon rate of 8.2 percent. The bond currently sells for $1,140. The corporate tax rate is 35 percent. a. What is the company’s cost of debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of debt % b. What is the company’s cost of equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of debt % c. What is the company’s weighted average cost of capital? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) WACC %

Explanation / Answer

a. We will find cost of debt using Financial calculator

N = 20, PMT= $82 (=0.082*1000), PV=-1140, FV= 1000

Solve for I/Y

I/Y = 6.89 %

Company's before tax cost of debt = 6.89%

Company's after tax cost of debt = 6.89 * (1-0.35) = 4.48 %

b. Return on Equity = (Risk free rate ) +[Beta* (Expected Return on the Market)- (Risk free Rate)]

= (3.6) + [1.15* (10-3.6)] = [(3.6) + (1.15*6,4)] = (3.6)+ (7.36) = 10.96

c. WACC = (Weight of Equity*Cost of Equity) + (Weight of Debt*After Cost of Debt)

= (0.625*10.96) + (0.375*4.48) = 8.53 %

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