Colt Manufacturing has two divisions: 1) pistols; and 2) rifles. Betas for the t
ID: 2794683 • Letter: C
Question
Colt Manufacturing has two divisions: 1) pistols; and 2) rifles. Betas for the two divisions have been determined to be beta (pistol)equals=0.6 and beta (rifle)equals=0.70. The current risk-free rate of return is 5%, and the expected market rate of return is 12%. The after-tax cost of debt for Colt is 7.5%. The pistol division's financial proportions are 40.0% debt and 60.0% equity, and the rifle division's are 50.0% debt and 50.0% equity.
a. What is the pistol division's WACC?
b.What is the rifle division's WACC?
Explanation / Answer
Beta of pistol = 0.6
Beta of rifle = 0.7
Risk free rate = 5%
Required return of pistol = 5% + 0.6 * (12% - 5%)
Required return of pistol = 9.20%
Required return of rifel = 5% + 0.7 * (12% - 5%)
Required return of rifel = 9.90%
After tax cost of debt = 7.5%
Pistol division WACC = 9.2% * 0.6 + 7.5% * 0.4
Pistol division WACC = 8.52%
Rifel division WACC = 9.9% * 0.5 + 7.5% * 0.5
Rifel division WACC = 8.70%