Corp Finance WACC question

CFA Level I Corporate Finance
#1

so the CFA book asked to provide the WACC for different D/E ratios

  • min. company can borrow is the 12month LIBOR + premium that varies with D/E ratio in the table below

D/E Spreads less than 0.4 200 0.4-0.49 300 0.5-0.59 400 0.6-0.69 600 0.7-0.79 800 0.8-0.89 1000 0.9 or higher

1200

  • 12month libor 4.25%

-market risk 4%, unleverged Beta 0.9

-risk free rate 4.25%

-company tax 36%

  1. determine the WACC for 10% intervals of D/E ratio based on the table above

  2. recommend a target capital structure on 10% intervals

This is the answer table according to the book

D/E Beta cost of debt cost of equity WACC 0.1 0.96 6.5 8.1 7.7 0.2 1.04 6.5 8.4 7.6 0.3 1.15 6.5 8.8 7.4 0.4 1.28 7.5 9.4 7.6 0.5 1.48 8.5 10.2 7.8 0.6 1.76 10.5 11.3 8.6 0.7 2.24 12.5 13.2 9.6 0.8 3.2 14.5 17.1 10.8 0.9 6.08 16.5 28.6 12.4

**i was able to calculate the WACC for D/E 0.1 and 0.2 but i keep getting the wrong WACC for 0.3 and 0.4 and of course the answer to question 2 is 0.3.

please help me figure out why i can’t get the 7.4 WACC

thanks,

#2

sorry here are the tables

  • min. company can borrow is the 12month LIBOR + premium that varies with D/E ratio in the table below

D/E Spreads less than 0.4 200 0.4-0.49 300 0.5-0.59 400 0.6-0.69 600 0.7-0.79 800 0.8-0.89 1000 0.9 or higher 1200

  • 12month libor 4.25%

-market risk 4%, unleverged Beta 0.9

-risk free rate 4.25%

-company tax 36%

  1. determine the WACC for 10% intervals of D/E ratio based on the table above

  2. recommend a target capital structure on 10% intervals

This is the answer table according to the book

D/E Beta cost of debt cost of equity WACC 0.1 0.96 6.5 8.1 7.7 0.2 1.04 6.5 8.4 7.6 0.3 1.15 6.5 8.8 7.4 0.4 1.28 7.5 9.4 7.6 0.5 1.48 8.5 10.2 7.8 0.6 1.76 10.5 11.3 8.6 0.7 2.24 12.5 13.2 9.6 0.8 3.2 14.5 17.1 10.8 0.9 6.08 16.5 28.6 12.4

#3

I don’t see how they’re getting beta for each D/E value.

#4

they are taking the average

so for D/E 0.2 they are taking 0.96+0.9/2 and so on for each D/E value

#5

CORRECTION: 12month LIBOR is 4.5%

#6

I’m not following this at all.

The equity beta should be a linear function of D/E. Their numbers aren’t linear.

Do they mention the formula that they’re using to get the equity beta, or do they just give you the table?

#7

sorry they don’t give any formulas, just the table. i figured it wasn’t linear since it is an MCC schedule.

it’s frustrating they don’t show the steps and this is the only example they provide.

thank you

#8

Sorry I couldn’t be of more help.

Where’d you get this question?

#9

no problem. this is right out of the CFA cirriculum for 2015, Marginal Cost of Capital Schedule, example 13. i even checked the Errata and nothing. Oh well…

#10

It seems only to be correct for the first D/E of 0.1 where relevering gets a Beta of 0.96.

#11

Not quite. I checked the curriculum. Where you have D/E, they have D/(D+E). Different beast.

Step 1: read the question.

Now that that’s cleared up, redo your calculations.

#12

LMAO, the D/E and the D/(D+E) can be so bitches. Always be careful which one is used.

#13

Thanks S2000magician. Now it works! Regards, Oscar

#14

Y’all are quite welcome.

#15

S**t totally messed that one up. my bad. thanks S2000magician

#16

You’re quite welcome.

#17

Hello,

I am struggling with this problem, which led to find this website.

I am having the same problem as Barclay. I understand that the example is using D/C instead of D/E.

What I am having trouble with (and I’m sure it is a simple oversight) is how to ‘convert’ the D/C to D/E.

Could anyone kindly point me in the right direction?

Thanks!

#18

E/C = 1 − D/C

(If you want to work that out from soup to nuts, note that C = E + D, so,

E/C = E / (E + D) = (E + D – D) / (E + D)

= (E + D) / (E + D) – D / (E + D) = 1 – D / (E + D) = 1 − D/C)

So,

D/E = (D/C) / (E/C) = (D/C) / (1 − D/C)

For example, if D/C = 0.6, then E/C = 0.4, and

D/E = 0.6 / 0.4 = 1.5.

#19

S2000magician,

Thank you! That is exactly what I was looking for. Makes perfect sense now!

Thanks!

#20

My pleasure.