Builder's Warehouse,Inc has an adjusted WACC of 9.70%.The company has a capital structure consisting of 50% equity and 50% debt,a cost of equity of 13.00%,a before-tax cost of debt of 8.00%,and a tax rate of 20%.Builder's Warehouse is considering expanding by building a new outlet in a distant city and considers the project to be riskier than current operations.The firm estimates the existing beta to be 1.0,the required return on the market portfolio to be 12.00%,the risk-free rate to be 3.00%,and the beta for the new project to be 1.25.Given this information,and assuming the cost of debt will not change if the firm undertakes the new project,what adjusted WACC should be used in the decision-making?

Question

Quizplus · Accepted Answer

The adjusted WACC for the new project can be calculated by adjusting the cost of equity to reflect the project's higher risk. The new cost of equity can be calculated using the CAPM formula: Cost of Equity = Risk-Free Rate + Beta(Project) * (Market Return - Risk-Free Rate) = 3% + 1.25 * (12% - 3%) = 14.25%. The adjusted WACC = 50% * 14.25% + 50% * (8% * (1 - 20%)) = 7.125% + 3.2% = 10.325%, which rounds to approximately 10.45%.

Builder's Warehouse,Inc Has an Adjusted WACC of 9