CoffeeStop primarily sells coffee. It recently introduced a premium coffee-flavored liquor.
Suppose the firm faces a tax rate of 25% and collects the following information. If it plans to finance
11% of the new liquor-focused division with debt and the rest with equity, what WACC should it use
for its liquor division? Assume a cost of debt of 4.8%, a risk-free rate of 3%, and a risk premium of
6%.
Beta % Equity % Debt
CoffeeStop 0.61 96 4
BF Liquors 0.26 89 11 Company’s current share price is $20 and it is expected to pay a $1 dividend next
year. After that, the firm’s dividends are expected to grow at a rate of 4% per year.
a. What is an estimate of Growth Company’s cost of equity?
Hint: Think back to our conversations on the dividend discount model! You’ll need to rearrange
an equation.
b. Growth Company also has preferred stock outstanding that pays a $2 per share fixed dividend
forever. If the stock is currently priced at $28, what is Growth Company’s cost of preferred
stock?
Hint: Think back to our conversations on the dividend discount model! You’ll need to rearrange
an equation.
c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm
just issued new debt at par with a coupon rate of 6.5%. What is Growth Company’s pretax cost
of debt? points - Avicorp has a $10 million debt issue outstanding, with a 6% coupon rate. The debt has
semiannual coupons, the next coupon is due in six months, and the debt matures in five years. It is
currently priced at 95% of par value.
a. What is Avicorp’s pre-tax cost of debt? Hint: the YTM as an APR would be a great estimate of the
pre-tax cost of debt.
b. If Avicorp faces a 40% tax rate, what is its after-tax cost of debt?
c. If Avicorp has a beta of 1.3 and the expected market return is 8.2% and the risk free rate is 3.6%,
what is its cost of equity?
d. What is Avicorp’s WACC assuming the debt listed above is the only debt Avicorp has and that it
has market equity value of $12 million? (Think: Should you use the face value of debt or market
value of debt for the weight of debt?)