The intel corporation has a book value of capital of $10,000,000. All of its cap

Question

The intel corporation has a book value of capital of $10,000,000. All of its capital is equity capital which has a current market value of $100,000,000. Its equity beta is 0.75. You have the following market information: The current 10 year Treasury bond rate is 3% The market risk premium is 6.2% The tax rate is 35% a. Please estimate its weighted average cost of capital, given its current capital structure b. The CFO of the intel corporation has decided to ask the board to approve his proposal to change the intel capital structure to 50% debt/ 50% equity in Market value terms. For the change in capital structure, the CFO has collected the following information: Intel can borrow money in the long term debt market at YTM of 7%, before taxes. With the proposed change in capital structure, the equity beta is expected to increase to 1.24. Please estimate the weighted average total cost of capital, given the proposed capital structure.

Explanation / Answer

a.

WACC = Weighted average cost of capital = Cost of equity as it is all in equity

Cost of equity using CAPM:

Cost of equity = Risk free rate + Beta x Market risk premium

Cost of equity = 3% + 0.75 x 6.2%

Cost of equity = WACC = 7.65%

b.

Cost of equity using CAPM:

Cost of equity = Risk free rate + Beta x Market risk premium

Cost of equity = 3% + 1.24 x 6.2%

Cost of equity = 10.6880%

.

WACC = Cost of equity x Weight of equity + Cost of debt x Weight of debt x (1-Tax rate)

WACC = 10.688% x 50% + 7% x 50% x (1-35%)

WACC = 7.6190%

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