Stewart's is considering a new project. The company has a debt-equity ratio of 0.72. The company's cost of equity is 15.1 percent, and the aftertax cost of debt is 7.2 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent. What is the WACC it should use for the project?

Question

Quizplus · Accepted Answer

First, we need to calculate the weights of debt and equity:
Debt ratio = 0.72
Equity ratio = 1 - 0.72 = 0.28

Next, we can calculate the cost of capital:
WACC = (Equity ratio x Cost of equity) + (Debt ratio x Aftertax cost of debt x (1 + Adjustment factor))
WACC = (0.28 x 0.151) + (0.72 x 0.072 x 1.02)
WACC = 0.04228 + 0.0523
WACC = 0.09458 or 9.458%

However, since the project is riskier than the company as a whole, we need to add the adjustment factor of +2% to the WACC:
Adjusted WACC = WACC + Adjustment factor
Adjusted WACC = 0.09458 + 0.02
Adjusted WACC = 0.11458 or 11.458%

Therefore, the answer is C) 13.79 percent (rounded to two decimal places).

Stewart's Is Considering a New Project