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Whispering Pines, Inc
Whispering Pines, Inc., is all-equity-financed. The expected rate of return on the company’s shares is 12.75%.
a. What is the opportunity cost of capital for an average-risk Whispering Pines investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
Cost of capital %
b. Suppose the company issues debt, repurchases shares, and moves to a 27% debt-to-value ratio (D/V = .27). What will be the company’s weighted-average cost of capital at the new capital structure? The borrowing rate is 8.25% and the tax rate is 40%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
Weighted-average cost of capital %
Expert Solution
Part (a):
Given, the firm is all-equity finance. Therefore, opportunity cost of capital is the expected rate of return on equity shares, given as 12.75%
Part (b):
WACC= We*Re + Wd*Rd*(1-T)
Where We= Proportion of equity, Re= cost of equity, Wd= proportion of debt, Rd= cost of debt and T= Tax rate.
Given, proposed weight of debt (Wd)= 0.27 and therefore, We= 1-0.27= 0.73
Also given, cost of equity (Re)= 12.75%, Cost of debt = 8.25% and tax rate (T)= 40%
Plugging the inputs,
WACC= 0.73*0.1275+0.27*0.0825*(1-0.40)
=0.093075 + 0.013365 = 0.10644 Or, 10.64% (rounded)
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