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Calculating WACC, Capital Structure

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Jingle Bell is 60% debt-financed and the expected return on its debt is 6%. Its equity
beta is 2. Risk-free rate of return is 4% and market risk premium is 4%. Assume Jingle Bell operates in a MM world with no taxes.

a) What is Jingle Bell's WACC?
b) An investor has invested all her savings (â?¬10,000) in bell production stock.
Suppose that she thinks that her current investment portfolio is too risky and
wants to reduce the expected return of her portfolio to 10%. How can she do this?
Assume that she can borrow and lend with the same rate of return as Jingle Bell
and that investing in other securities is not an option.
c) If Jingle Bell wanted its stock to have the expected rate of return required by the
investor (10%), how should the company change its capital structure? Assume
that the expected return on debt is not affected by changes in capital structure.

use formulas, not excel

Solution Preview

a.
Re=Rf+Beta*(Rm-Rf)=4%+2*4%=12%
WACC=Rd*D/(D+E)+Re*E/(D+E)=6%*60%+12%*40%=8.4%
b.
The required rate of return of Jingle ...

Solution Summary

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