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# WACC

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The Super Muench Cookie Company has a capital structure consisting of 30% debt and 70% equity based on market values. Company's equity beta based on its current level o debt financing is 1.8 and its debt beta is 0.6. Also, the risk free rate of interest is currently 3% on long-term government bonds. The company's pre-tax cost of debt is 9%. Investment banker advised the firm that according to her estimates, the market risk premium is 12%.

a. What is your estimate of the cost of equity capital for The Super Muench Cookie Company based on the CAPM?
b. If company's marginal tax rate is 30%, what is the firm's overall weighted average cost of capital?
c. The Super Muench Cookie Company is considering a diversification effort that would move it into small retail outlets at major malls around the country. Super Muench believes that for the riskier retail outlet portion of its business, a more conservative capital structure of 20% debt and 80% equity is more appropriate. Estimate WACC for the project.

use formulas (not excel)

#### Solution Preview

a. Using CAPM
Cost of equity = Rf + (Rm-Rf) beta
Rf = risk free rate = 3%
(Rm-Rf) = market risk premium = 12%
beta = 1.8
Cost of equity = 3% + 12% X 1.8 = 24.6%

b. WACC = Proportion of debt X after tax cost of debt + Proportion of equity X cost of equity
Proportion of debt = 30%
After ...

#### Solution Summary

The solution explains how to calculate the WACC for the company and for a project

\$2.19

## Figuring the WACC, the unlevered beta & WACC with new capital structure

As the Vice President of a Finance company with the following available data:

Total assets \$ 10,000,000.00
Debt \$ 2,500,000.00
common equity \$ 7,500,000.00
before tax cost of debt 12.00%
risk-free rate 5.00%
Market Return 16.00%
beta at current capital structure 1.20
Tax Rate 40%

What is my firms's current Weighted Average Cost of Capital (WACC)?

What is my firm's unlevered beta?

If I am considering changing my firm's capital structure to 40% debt and 60% common equity, to make this change, I will issue additional debt and use the proceeds to repurchase common stock. If I do this, the before tax cost of debt will rise to 14%. What would be my firm's WACC if you adopt this new capital structure?

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