Speedy Delivery Systems can buy a piece of equipment that should provide an 5 pe

Question

Speedy Delivery Systems can buy a piece of equipment that should provide an 5 percent return and can be financed at 2 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 13 percent return but would cost 15 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm

Speedy Delivery Systems can buy a piece of equipment that should provide an 5 percent return and can be financed at 2 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 13 percent return but would cost 15 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm

Explanation / Answer

Hi,

Please find the answer as follows:

WACC = Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity = 2*.50 + 15*.50 = 8.5%

Answer is 8.5%.

Thanks.

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