Case Scenario: The Super Muench Cookie Company has a capital structure consisting of 30% debt and 70% equity based on market values. Company's equity beta based on its current level o debt financing is 1.8 and its debt beta is 0.6. Also, the risk free rate of interest is currently 3% on long-term government bonds. The company's pre-tax cost of debt is 9%. Investment banker advised the firm that according to her estimates, the market risk premium is 12%.
Q1. What is your estimate of the cost of equity capital for The Super Muench Cookie Company based on the CAPM?
Q2. If company's marginal tax rate is 30%, what is the firm's overall weighted average cost of capital?
Q3. The Super Muench Cookie Company is considering a diversification effort that would move it into small retail outlets at major malls around the country. Super Muench believes that for the riskier retail outlet portion of its business, a more conservative capital structure of 20% debt and 80% equity is more appropriate. Estimate WACC for the project.