The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta
ID: 2797427 • Letter: T
Question
The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of .9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCI’s capital structure is 38% debt, paying an interest rate of 7%, and 62% equity. The debt sells at par. Buildwell pays tax at 40%.
What is BCCI’s cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
If BCCI is presented with a project with an internal rate of return of 12%, should it accept the project if it has the same level of risk as the current firm?
The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of .9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCI’s capital structure is 38% debt, paying an interest rate of 7%, and 62% equity. The debt sells at par. Buildwell pays tax at 40%.
Explanation / Answer
Risk Free rate = 4%
Market Risk Premium = 8%
Beta = 0.9
Cost of Capital by CAPM = 4% + 0.9 * 8%
Cost of Capital by CAPM = 11.2%
Part B
Cost of Debt = 7%
Weight of Debt = 0.38
Weight of Equity = 0.62
Cost of Equity = 11.2%
Tax rate = 40%
WACC = 7% * (1 - 40%) * 0.38 + 0.62 * 11.2%
WACC = 8.54%
Part C
As Project's internal rate of return is greater than WACC, we will accept the project