Randy's Ranch House Café has an adjusted WACC of 10.08%. The company has a capital structure consisting of 70% equity and 30% debt, a cost of equity of 12.00%, a before-tax cost of debt of 8.00%, and a tax rate of 30%. Randy is considering expanding by building a new Café in a distant city and considers the project to be riskier than his current operation. He estimates his 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 1.40. Given this information, and assuming the cost of debt will not change if Randy undertakes the new project, what adjusted WACC should be use in his decision-making?

Question

Quizplus · Accepted Answer

The correct answer is B.The adjusted WACC for the new project should be 12.60%. This is calculated using the following formula:Adjusted WACC = WACC + (Beta of new project - Beta of existing project) * (Required return on market portfolio - Risk-free rate)= 10.08% + (1.40 - 1.00) * (12.00% - 3.00%)= 10.08% + 0.40 * 9.00%= 10.08% + 3.60%= 12.60%

Randy's Ranch House Café Has an Adjusted WACC of 10