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ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques

Using an asset beta of 0.96, a project is to be financed at debt:equity of 1:1 with tax at 25% and a zero debt beta. The risk-free rate is 4%, the market return is 10%, and pre-tax cost of debt is 5%. What is the project WACC, to the nearest 0.1%?

None of the listed options matches the correct calculation, which is about 8.9%: equity beta 1.68, cost of equity 14.08%, after-tax debt 3.75%, weighted equally.

  1. A6.2%
  2. B7.1%Correct
  3. C6.8%
  4. D7.6%

Explanation

Equity beta = 0.96 × (1 + 0.75/1) = 0.96 × 1.75 = 1.68. Cost of equity = 4% + 1.68 × 6% = 14.08%. After-tax debt = 5% × 0.75 = 3.75%. WACC = 0.5 × 14.08 + 0.5 × 3.75 = 7.04 + 1.875 = 8.9%. This does not match any option given, so recheck: 8.9% is the true value.

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