Gnomes R Us is considering a new project. The company has a debt–equity ratio of

Question

Gnomes R Us is considering a new project. The company has a debt–equity ratio of .88. The company’s cost of equity is 14.8 percent, and the aftertax cost of debt is 8.1 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent.

What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
WACC             %

What discount rate should the firm use for the project? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Project discount rate             %

Explanation / Answer

1.Calculation of WACC:

0.88 debt - equity ratio

=>$0.88 debt for $1.00 equity ratio

=>weight of debt = 0.88 / 1.88.

=>weight of equity =>1.00/ 1.88.

now,

WACC = [weight of debt *after tax cost of debt] + [weight of equity * cost of equity]

=>[0.88/1.88 * 0.081] +[1.00/1.88 * 0.148]

=>[0.03791489361]+[0.07872340425]

=>0.11663829786

=>11.66%........(rounded to two decimals).

b.Project discount rate = WACC + adjustment factor

=>11.66% + 2%

=> 13.66%

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.