Question

The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of .9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCI’s capital structure is 30% debt, paying a 5% interest rate, and 70% equity. Buildwell pays tax at 40%. (LO13-1) a. What is BCCI’s cost of equity capital? b. What is its WACC? c. If BCCI is presented with a normal project with an internal rate of return of 12%, should it accept the project?

Answer 1

Answer:

a. 11.2%

b. 8.74%

c. Yes

Explanation:

The computation is shown below:

a. The cost of equity capital is

Cost of equity capital =  Risk free rate of return + Beta × Market risk premium

= 4% + 0.9 × 8%

= 4% + 7.2%

= 11.2%

b. Now the WACC is

= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of  common stock) × (cost of common stock)

= (0.3 × 5%) × ( 1 - 40%) +  (0.7 × 11.2%)

= 0.9%  + 7.84%

= 8.74%

c. Yes the project should be accepted as the internal rate of return is greater than the cost of equity capital