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Corning Inc. currently has a capital structure of 20 percent debt and 80 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 58 percent debt and 42 percent equity. Corning has a current beta of 1.4, but is not sure what the beta for the new division will be. Ball Corporation is a firm that produces a product similar to the product under consideration by Corning. Ball has a beta of 1.6, a capita structure of 25 percent debt and 75 percent equity and a marginal tax rate of 40 percent. Corning's tax rate is 35 percent. What will be Corning's weighted average cost of capital for this new division if the after-tax cost of debt is 12 percent, the risk-free rate is 5 percent, and the market risk premium is 10 percent? 14.37% 17.25% 19.69% 10.56%

Corning Inc. currently has a capital structure of 20 percent debt and 80 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 58 percent debt and 42 percent equity. Corning has a current beta of 1.4, but is not sure what the beta for the new division will be. Ball Corporation is a firm that produces a product similar to the product under consideration by Corning. Ball has a beta of 1.6, a capita structure of 25 percent debt and 75 percent equity and a marginal tax rate of 40 percent. Corning's tax rate is 35 percent. What will be Corning's weighted average cost of capital for this new division if the after-tax cost of debt is 12 percent, the risk-free rate is 5 percent, and the market risk premium is 10 percent? 14.37% 17.25% 19.69% 10.56%

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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**Case Study: Calculating Weighted Average Cost of Capital (WACC) for Corning Inc.'s New Division** Corning Inc. currently maintains a capital structure composed of 20% debt and 80% equity. The company is considering launching a new product, to be managed by a new division. This new division is expected to have a capital structure of 58% debt and 42% equity. Corning is aware that the company has a current beta of 1.4 but is uncertain about the beta for the new division. To estimate this, Corning looks at Ball Corporation, a firm with a similar product line. Ball has a beta of 1.6, a capital structure consisting of 25% debt and 75% equity, and a marginal tax rate of 40%. Corning's tax rate is 35%. **Objective:** Determine the weighted average cost of capital (WACC) for Corning's new division, given the following: - The after-tax cost of debt is 12%. - The risk-free rate is 5%. - The market risk premium is 10%. **Options:** - 14.37% - 17.25% - 19.69% - 10.56% **Key Concepts:** 1. **Capital Structure:** The mix of debt and equity used to finance the new division. 2. **Beta:** A measure of the division's risk compared to the market. Aligning the beta of Corning’s new division with a similar company (Ball Corporation) helps in estimating the risk. 3. **WACC Formula:** \[ \text{WACC} = \left( E/V \right) \times \text{Re} + \left( D/V \right) \times \text{Rd} \times (1 - \text{Tax rate}) \] Where: - \( E \) = Market value of equity - \( D \) = Market value of debt - \( V \) = \( E + D \) = Total market value of the firm's financing (equity and debt) - \( \text{Re} \) = Cost of equity - \( \text{Rd} \) = Cost of debt **Note:** The exercise involves applying the formula with provided percentages and market values to find the accurate WACC of Corning's new division.
Transcribed Image Text:**Case Study: Calculating Weighted Average Cost of Capital (WACC) for Corning Inc.'s New Division** Corning Inc. currently maintains a capital structure composed of 20% debt and 80% equity. The company is considering launching a new product, to be managed by a new division. This new division is expected to have a capital structure of 58% debt and 42% equity. Corning is aware that the company has a current beta of 1.4 but is uncertain about the beta for the new division. To estimate this, Corning looks at Ball Corporation, a firm with a similar product line. Ball has a beta of 1.6, a capital structure consisting of 25% debt and 75% equity, and a marginal tax rate of 40%. Corning's tax rate is 35%. **Objective:** Determine the weighted average cost of capital (WACC) for Corning's new division, given the following: - The after-tax cost of debt is 12%. - The risk-free rate is 5%. - The market risk premium is 10%. **Options:** - 14.37% - 17.25% - 19.69% - 10.56% **Key Concepts:** 1. **Capital Structure:** The mix of debt and equity used to finance the new division. 2. **Beta:** A measure of the division's risk compared to the market. Aligning the beta of Corning’s new division with a similar company (Ball Corporation) helps in estimating the risk. 3. **WACC Formula:** \[ \text{WACC} = \left( E/V \right) \times \text{Re} + \left( D/V \right) \times \text{Rd} \times (1 - \text{Tax rate}) \] Where: - \( E \) = Market value of equity - \( D \) = Market value of debt - \( V \) = \( E + D \) = Total market value of the firm's financing (equity and debt) - \( \text{Re} \) = Cost of equity - \( \text{Rd} \) = Cost of debt **Note:** The exercise involves applying the formula with provided percentages and market values to find the accurate WACC of Corning's new division.
Expert Solution
Step 1: Introduction:

The beta value depicts the risk associated with security investment which is of an uncontrollable nature. The beta measure is used for finding the required return rate on equity for the offered riskless rate and the market rate of return..

The formula for levered beta:

L e v e r e d space b e t a equals U n l e v e r e d space b e t a left parenthesis 1 plus left parenthesis 1 minus t a x right parenthesis asterisk times left parenthesis d e b t divided by e q u i t y right parenthesis right parenthesis


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