Rogue Industries,Inc has an adjusted WACC of 8.56%.The company has a capital structure consisting of 80% equity and 20% debt,a cost of equity of 10.00%,a before-tax cost of debt of 6.00%,and a tax rate of 20%.The firm is considering expanding by building a new shop in a distant city and considers the project to be less risky than the current operation.The firm has an existing beta of 1.0,the required return on the market portfolio to be 10.00%,the risk-free rate to be 3.00%,and the beta for the new project to be 0.90.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 decision-making?

Question

Quizplus · Accepted Answer

The adjusted WACC for the new project can be calculated using the formula: WACC = E/V * Re + D/V * Rd * (1 - Tc), where E/V is the proportion of equity, Re is the cost of equity, D/V is the proportion of debt, Rd is the cost of debt, and Tc is the tax rate. Given the new project is less risky, the beta for the new project is 0.90. The cost of equity for the new project can be recalculated using the CAPM model: Re = Rf + Beta * (Rm - Rf), where Rf is the risk-free rate, Beta is the beta of the project, and Rm is the market return. Substituting the given values, the new cost of equity becomes 9.3% (3% + 0.90 * (10% - 3%)). Using these values in the WACC formula gives an adjusted WACC of approximately 8.40%.

Rogue Industries,Inc Has an Adjusted WACC of 8