Templeton Extended Care Facilities, Inc. is considering the acquisition of a chain of cemeteries for $370 million. Since the primary asset of this business is real estate, Templeton's management has determined that they will be able to borrow the majority of the money needed to buy the business. The current owners have no debt financing but Templeton plans to borrow $290 million and invest only $80 million in equity in the acquisition. What weights should Templeton use in computing the WACC for this acquisition? Round to one decimal place
To compute the weighted average cost of capital (WACC) for the acquisition, Templeton needs to determine the weights of the debt and equity components. The weight of each component represents its proportion in the overall capital structure. In this case, Templeton plans to borrow $290 million and invest $80 million in equity.
To calculate the weights, divide each component by the total capitalization:
Debt weight = Debt / Total capitalization
Equity weight = Equity / Total capitalization
Total capitalization = Debt + Equity
In this scenario:
Debt = $290 million
Equity = $80 million
Total capitalization = $290 million + $80 million = $370 million
Debt weight = $290 million / $370 million
Debt weight = 0.7838 (rounded to four decimal places)
Equity weight = $80 million / $370 million
Equity weight = 0.2162 (rounded to four decimal places)
Therefore, Templeton should use a debt weight of 0.8 and an equity weight of 0.2 (rounded to one decimal place) when computing the WACC for this acquisition.