Outdoor Experiences Inc. needs to estimate the cost of capital for the evaluatio

Question

Outdoor Experiences Inc. needs to estimate the cost of capital for the evaluation of capital expenditures. A typical project is financed with 25% debt-to-value ratio (i.e., D/(D+E) = 0.25). Adventure Travel, a publicly traded firm in the same business as Outdoor Experiences, is financed with 20% debt-to-value ratio and has an equity Beta of 0.9. For both corporations, the cost of debt is 8% and the corporate tax rate is 35%. Assume that the risk free rate is 4% and the expected market risk premium is 7%.

a) Find the cost of equity of Outdoor Experiences.

b) Find the WACC for Outdoor Experiences.

Explanation / Answer

a) Cost of Equity as per Capm Model = Risk free rate + Beta * ( Market return - risk free rate) = 4% + 0.9 * 7% = 0.103 or 10.3%

WACC = Cost of Debt* (D/(D+E) * ( 1- tax rate) + Cost Of Equity * E/(D+E) = 8% * 0.25 * ( 1- 35%) + 10.3% * 0.75 = 9.025%

Best of Luck. God Bless

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.