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 .65. The company’s cost of equity is 13.2 percent, and the aftertax cost of debt is 5.1 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +3 percent.

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

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

Gnomes R Us is considering a new project. The company has a debt-equity ratio of .65. The company’s cost of equity is 13.2 percent, and the aftertax cost of debt is 5.1 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +3 percent.

Explanation / Answer

Debt Equity Ratio =.65 Debt/Equity = .65 Debt = .65 Equity Debt + Equity =1 .65 Equity + Equity = 1 1.65 Equity = 1 Equity = 1/1.65 = .6061 Debt = 1 - .6061 = .3939 Statement showing computationof WACC Particulars Cost of Capital Weight Weighted Cost of capital Equity 13.20% 0.6061 8.00% Debt 5.10% 0.3939 2.01% 1.0000 10.01% WACC = 10.01% Project Discount rate = 10.01% + 3% Project Discount rate = 13.01%

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