The required return on the stock of Moe's Pizza is 10.6 percent and aftertax required return on the company's debt is 3.34 percent. The company's market value capital structure consists of 67 percent equity. The company is considering a new project that is less risky than current operations and it feels the risk adjustment factor is minus 1.7 percent. The tax rate is 40 percent. What is the required return for the new project?

Question

Business

Parker Small

20 January, 00:22

The required return on the stock of Moe's Pizza is 10.6 percent and aftertax required return on the company's debt is 3.34 percent. The company's market value capital structure consists of 67 percent equity. The company is considering a new project that is less risky than current operations and it feels the risk adjustment factor is minus 1.7 percent. The tax rate is 40 percent. What is the required return for the new project?

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Gregory Hess · Answer 1

6.5%

Explanation:

Firstly, we need to calculate weighted average cost of capital (WACC) as below

WACC = Weight of equity x Cost of equity + Weight of debt x Cost of debt x (1 - Tax rate)

= 67% x 10.6% + (1 - 67%) x 3.34%

= 8.2%

Then, we will add the risk adjustment factor to this WACC to get the proper WACC of the new project, which is 8.2% - 1.7% = 6.5%