Technico plans to start a new product division that will have a capital structure of 70 percent debt and 30 percent equity. The leveraged beta for this division has been estimated to be 2.02. What will be Technico's weighted cost of capital for this new division if the after-tax cost of debt is 7 percent, the risk-free rate is 8 percent, and the market risk premium is 5 percent?
A) 14.77%
B) 10.33%
C) 18.1%
D) 1.03%

Question

Quizplus · Accepted Answer

To calculate the weighted cost of capital (WACC) for Technico's new division, we first need to calculate the cost of equity using the Capital Asset Pricing Model (CAPM). The formula for CAPM is:$$ \text{Cost of Equity} = \text{Risk-Free Rate} + \text{Beta} \times \text{Market Risk Premium} $$Given:- Risk-Free Rate = 8%- Beta = 2.02- Market Risk Premium = 5%$$ \text{Cost of Equity} = 8\% + 2.02 \times 5\% = 8\% + 10.1\% = 18.1\% $$Now, we can calculate the WACC using the formula:$$ \text{WACC} = \text{Weight of Equity} \times \text{Cost of Equity} + \text{Weight of Debt} \times \text{After-Tax Cost of Debt} $$Given:- Weight of Equity = 30% or 0.3- Weight of Debt = 70% or 0.7- After-Tax Cost of Debt = 7%$$ \text{WACC} = 0.3 \times 18.1\% + 0.7 \times 7\% = 5.43\% + 4.9\% = 10.33\% $$Therefore, the weighted cost of capital for Technico's new division is 10.33%.

Technico Plans to Start a New Product Division That Will