| Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.8, 1.1, 1.5, and 1.7, respectively. Assume all current and future projects will be financed with 20 percent debt and 80 percent equity, the current cost of equity (based on an average firm beta of 1.3 and a current risk-free rate of 5 percent) is 14 percent and the after-tax yield on the company’s bonds is 10 percent. |
| What will the WACCs be for each division? (Do not round intermediate calculations and round your final answers to 2 decimal places.) |
| WACCs | |
| Division A | % |
| Division B | % |
| Division C | % |
| Division D | % |
Answer
Step 1:
Find the market risk premium.
14% = 5% + 1.3(MRP);
= > MRP = 6.92%.
Step 2:
Find the cost of equity for each division using CAPM;
A:
6.92 + .8 * 6.92
= 12.45%;
B:
14%;
C:
17.3%;
D:
18.68%
Calculation for the above answer
| MRp | Avg Beta |
|||
| A | 6.92 | 0.8 | 5.536 | 12.456 |
| B | 6.92 | 1.1 | 7.612 | 14.532 |
| C | 6.92 | 1.5 | 10.38 | 17.3 |
| D | 6.92 | 1.7 | 11.764 | 18.684 |
; Step 3:
Find the WAACs for each division
; A:
.8(12.46%) + .8(8%)
= 10.04%;
B
:16.10%;
C:
26.1%;
D:
31.93%
Calculaion for the above answer
| (A) | Avg Beta (B) |
( C ) = (A*B) |
Company Bond rate D |
E=D*B | F | |
| A | 12.456 | 0.8 | 9.9648 | 10% | 0.08 | 10.0448 |
| B | 14.532 | 1.1 | 15.9852 | 10% | 0.11 | 16.0952 |
| C | 17.3 | 1.5 | 25.95 | 10% | 0.15 | 26.1 |
| D | 18.684 | 1.7 | 31.7628 | 10% | 0.17 | 31.9328 |
