Blues, Inc. is an MNC located in the U.S. Blues would like to estimate its weigh
ID: 2711946 • Letter: B
Question
Blues, Inc. is an MNC located in the U.S. Blues would like to estimate its weighted average cost of capital. On average, bonds issued by Blues yield 5.42%. Currently, T-bill rates are 0.32% (0.0032 in decimals). Furthermore, Blues' stock has a beta of 1.34, and the return on the Wilshire 5000 stock index (a measure of the return on the market) is expected to be 11.50%. Blues has a debt-to-equity ratio (D/E) of 47% (or 0.47 in decimals). If Blues is in the 35% tax bracket, what is its (a) aftertax cost of debt, (b) cost of equity (ke), and (c) weighted average cost of capital (kc)? NOTE: Round to at least 4 decimal places in all intermediate calculations. Give your final answers for (a), (b), and (c) in percent, rounded to 2 decimal places.
Explanation / Answer
(a) After tax cost of debt = 5.42% * (1 - 35%)
= 3.52%
(b) Cost of equity = 0.32% + 1.34 * (11.50% - 0.32%)
= 15.30%
(c) Debt ratio = 1 - [1 / (1 + D/E)]
= 1 - 1 / (1 + 0.47)
= 0.32
Weighted average cost of capital = 3.52% * 0.32 + 15.30% * 0.68
= 11.53%