Acme Business Connections (ABC) has an adjusted WACC of 8.56%. The com

Acme Business Connections (ABC) has an adjusted WACC of 8.56%. The company has a capital structure consisting of 60% equity and 40% debt, a cost of equity of 11.00%, a before-tax cost of debt of 7.00%, and a tax rate of 30%.

ABC is considering expanding by building a new shop in a distant city and considers the project to be riskier than the current operation. ABC has an existing beta of 1.0, the required return on the market portfolio to be 11.00%, the risk-free rate to be 3.00%, and the beta for the new project to be 1.30. Given this information, and assuming the cost of debt will not change if ABC undertakes the new project, what adjusted WACC should be used in decision-making?
A) 8.56%
B) 9.84%
C) 10.00%
D) 11.24%

ANSWER

Answer: C
Explanation: C) Re = E(ri) = rf + [E(rm) – rf] βi = 3.00% + [11.00% – 3.00%] × 1.3 = 13.40%.
WACC = × Rd × (1 – Tc) + × Re = 0.40 × (7.00%) × (1 – .30) + 0.60 × (13.40%) = 10.00%.