Colt Manufacturing has two divisions: 1) pistols; and 2) rifles. Betas for the t
ID: 2796395 • 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)=0.8 and beta (rifle)=1.3. The currentrisk-free rate of return is 3%, and the expected market rate of return is 8%. The after-tax cost of debt for Colt is 5.5%. The pistol division's financial proportions are 35.0% debt and 65.0% equity, and the rifle division's are 45.0% debt and 5.0% equity.
a. What is the pistol division's WACC?
b. What is the rifle division's WACC?
Explanation / Answer
WACC = cost of debt * (1-tax)*debt + cost of equity*equity
for Pistol
debt = .35
equity = .65
beta = 0.8
cost of equity = risk free rate + beta *( market return - risk free return)
cost of equity for pistol = .03 + .8 * (.08-.03) = 7%
cost of equity for rifle = .03 + 1.3*(.08-.03) = 9.5%
So WACC for pistol = .055*.35 + .07*.65 = 6.475%
for rifle
debt = .45
equity = .55
WACC for rifle= .055*.45 + .095*.55 = 7.7%