Unit 10 Assessment — The Cost of Capital

⚖️ WACC Formula

💳 Cost of Debt (r_d)

📈 Cost of Equity (r_s)

🏗️ Capital Structure Concepts

WACC

Full WACC FormulaWACC = w_d×r_d(1−T) + w_p×r_p + w_s×r_s

Weight of Debt (w_d)Market value of debt ÷ Total market value of firm

Weight of Preferred (w_p)Market value of preferred ÷ Total market value

Weight of Equity (w_s)Market value of equity ÷ Total market value

Tax Shield on DebtInterest is tax-deductible → after-tax cost = r_d × (1 − T)

Cost of Debt

After-Tax Cost of Debtr_d(1 − T) — use YTM of existing debt

New Debt CostUse YTM on new bonds being issued

Cost of Preferred Stockr_p = D_p ÷ P_p (no tax adjustment — not deductible)

Flotation CostsReduce net proceeds; increase effective cost

Marginal CostUse current market rates, not historical coupon rates

Cost of Equity

CAPM Approachr_s = r_RF + (RP_M) × β

DCF / Gordon Growthr_s = D₁/P₀ + g

Bond-Yield + Risk Premiumr_s ≈ r_d + Equity Risk Premium (3–5%)

Retained Earnings vs. New StockNew stock issuance: add flotation cost to denominator

New Stock Formular_e = D₁ ÷ [P₀×(1 − F)] + g

Capital Structure & Hurdle Rate

Hurdle RateWACC = minimum required return on new investments

Accept / Reject RuleAccept if project return > WACC; reject if < WACC

Optimal Capital StructureMix of debt & equity that minimizes WACC

Divisional WACCRiskier divisions need higher hurdle rate than firm WACC

Marginal Cost of CapitalWACC rises as firm raises more capital (breakpoints)

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out of 100 points

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Section 1

—/40

Multiple Choice

Section 2

—/20

True / False

Section 3

—/20

Short Answer

Section 4

—/20

Extended Response

⚠ Sections 3 & 4 are teacher-graded. Use the rubric selectors below to finalize the score.

Multiple Choice

Select the best answer · Includes WACC, component cost & hurdle rate calculations

2 pts each · 40 pts

Click the best answer. Use the formula reference panel and WACC component strip above. Each question is worth 2 points.

True or False

Click TRUE or FALSE for each statement

2 pts each · 20 pts

Select TRUE or FALSE for each statement. Each is worth 2 points.

Short Answer

Show all calculations + explain in 2–4 sentences · Teacher-graded

5 pts each · 20 pts

Answer in 2–4 complete sentences. Show every calculation step clearly. Rubric selectors appear after grading.

Extended Response — Bessemer Community Enterprises: Full WACC Analysis

Compute all 3 component costs · Full WACC · Evaluate 3 projects · Teacher-graded

20 pts

Read the scenario carefully. Write a well-organized analytical memo of at least 8 sentences. Show all calculations with labeled steps. Use and underline at least four unit vocabulary terms.

📋 Scenario — Bessemer Community Enterprises: WACC & Capital Budgeting Decision

Bessemer Community Enterprises (BCE) is a CDFI-supported small business development company that provides capital to Black-owned businesses in the corridor. BCE's finance committee has asked you to calculate the firm's WACC and use it to evaluate three proposed expansion projects. All financing uses BCE's current target capital structure.

Capital Structure (Market Values)

Debt: 40% · Preferred Stock: 10% · Common Equity: 50%

Cost of Debt

Pre-tax YTM on new bonds: 8% · Corporate tax rate: 25%

Cost of Preferred Stock

Annual dividend: $4.50 · Net price after flotation: $50.00

Cost of Equity (CAPM)

r_RF = 4.5% · Market risk premium = 6.0% · Beta = 1.20

Project A — Tech Hub

Expected return: 12.5% · Risk level: similar to firm average

Project B — Loan Fund

Expected return: 9.5% · Risk level: similar to firm average

Project C — Real Estate

Expected return: 11.0% · Risk level: similar to firm average

Community Impact Note

BCE aims to maximize community wealth — but financial sustainability requires meeting the hurdle rate.

35 Write your full WACC analysis memo covering all four parts: (a) Calculate each component cost: after-tax cost of debt, cost of preferred stock, and cost of equity using CAPM — show each step; (b) Calculate BCE's full WACC using the target weights — show the weighted calculation for all three components; (c) Evaluate Projects A, B, and C — for each, state whether BCE should accept or reject the project by comparing the project's expected return to the WACC hurdle rate, and briefly explain the accept/reject logic; (d) Explain in 2–3 sentences why a community development enterprise like BCE still must use WACC as its hurdle rate even when social impact is a goal — what happens financially if BCE consistently accepts projects below its WACC? Use at least four underlined vocabulary terms.

📋 Teacher Scoring Rubric

Criterion	Excellent (Full)	Proficient (Partial)	Developing (Minimal)	Score
Part (a) — Component Costs r_d(1−T) = 8%×0.75 = 6.0% · r_p = $4.50÷$50 = 9.0% · r_s = 4.5%+6%×1.2 = 11.7%	All three costs correct with formulas shown; tax shield applied to debt only	Two of three correct; minor arithmetic error on one	Only one correct or tax adjustment missing on debt	/6
Part (b) — Full WACC WACC = 0.40×6%+0.10×9%+0.50×11.7% = 2.4+0.9+5.85 = 9.15%	WACC = 9.15% (or close) with all three weighted terms shown	Correct method; arithmetic error within ±0.3%; or one weight missing	Wrong weights used or formula set up incorrectly	/5
Part (c) — Project Evaluation A: 12.5% > 9.15% → Accept · B: 9.5% > 9.15% → Accept (marginal) · C: 11.0% > 9.15% → Accept	All three correctly compared to WACC; accept/reject logic stated for each with brief justification	Two correctly evaluated; one missing comparison or wrong conclusion	Fewer than two correct; no explicit comparison to WACC	/5
Part (d) — WACC as Community Hurdle Rate	Explains that consistently accepting sub-WACC projects destroys firm value, erodes investor confidence, and eventually threatens BCE's ability to access capital — undermining its community mission long-term	Financial sustainability argument made but connection to community mission thin	Vague response; no financial consequence identified	/4

Extended Response Total: — / 20

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The Costof Capital

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The Cost
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