Corp Finance WACC question

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Barcaly

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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,
 
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
 
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
 
Barcaly wrote: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
Click to expand...
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?
 
S2000magician wrote:
Barcaly wrote: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
Click to expand...
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?
Click to expand...
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
 
Barcaly wrote:
S2000magician wrote:
Barcaly wrote: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
Click to expand...
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?
Click to expand...
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
Click to expand...
Sorry I couldn’t be of more help.
Where’d you get this question?
 
S2000magician wrote:
Barcaly wrote:
S2000magician wrote:
Barcaly wrote: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
Click to expand...
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?
Click to expand...
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
Click to expand...
Sorry I couldn’t be of more help.
Where’d you get this question?
Click to expand...
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..
 
It seems only to be correct for the first D/E of 0.1 where relevering gets a Beta of 0.96.
 
Barcaly wrote:
S2000magician wrote:
Barcaly wrote:
S2000magician wrote:
Barcaly wrote: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
Click to expand...
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?
Click to expand...
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
Click to expand...
Sorry I couldn’t be of more help.
Where’d you get this question?
Click to expand...
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..
Click to expand...
Not quite. I checked the curriculum. Where you have D/E, they have D/(D+E). Different beast.
Step 1: read the <blessed> question.
Now that that’s cleared up, redo your calculations.
 
LMAO, the D/E and the D/(D+E) can be so bitches. Always be careful which one is used.
 
S**t totally messed that one up. my bad. thanks S2000magician
 
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!
 
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.
 
S2000magician,
Thank you! That is exactly what I was looking for. Makes perfect sense now!
Thanks!
 
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