HW Assignment 7 Chapter 10
HW Assignment 7 Chapter 10
10-10 If the investment requires $5.9 million, that means that it requires $3.54 million (60%) of common equity and $2.36 million (40%) of debt. In this scenario, the firm would exhaust its $2 million of retained earnings and be forced to raise new stock at a cost of 15%. Needing $2.36 million in debt, the firm could get by raising debt at only 10%. Therefore, its weighted average cost of capital is: WACC = 0.4(10%)(1 – 0.4) + 0.6(15%) = 11.4%.
10-11 rs = D1/P0 + g = $2(1.07)/$24.75 + 7%
= 8.65% + 7% = 15.65%.
WACC = wd(rd)(1 – T) + wc(rs); wc = 1 – wd.
13.95% = wd(11%)(1 – 0.35) + (1 – wd)(15.65%)
0.1395 = 0.0715wd + 0.1565 – 0.1565wd
-0.017 = -0.085wd
wd = 0.20 = 20%.
10-20 a. After-tax cost of new debt: rd(1 – T) = 0.09(1 – 0.4) = 5.4%.
Cost of common equity: Calculate g as follows:
With a financial calculator, input N = 9, PV = -3.90, PMT = 0, FV = 7.80, and then solve for I/YR = g = 8.01%
»
8%.
rs = 
+ g = 
+ 0.08 = 
+ 0.08 = 0.146 = 14.6%.
b. WACC calculation:
After-tax Weighted
Component Weight
´
Cost = Cost
Debt [0.09(1 – T)] 0.40 5.4% 2.16%
Common equity (RE) 0.60 14.6 8.76
WACC = 10.92%
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