A company is 47% financed by risk-free debt. The interest rate is 12%, the expec
ID: 2711315 • Letter: A
Question
A company is 47% financed by risk-free debt. The interest rate is 12%, the expected market risk premium is 10%, and the beta of the company’s common stock is 0.57.
What is the company cost of capital? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
What is the after-tax WACC, assuming that the company pays tax at a 30% rate? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
A company is 47% financed by risk-free debt. The interest rate is 12%, the expected market risk premium is 10%, and the beta of the company’s common stock is 0.57.
Explanation / Answer
(i) cost of capital in this problem can be calculated by using Capital Asset Pricing Model (CAPM) with he following equation Re = rf + (rm – rf) * Where: Re = the required rate of return on equity rf = the risk free rate rm – rf = the market risk premium = beta coefficient = unsystematic risk there for cost of capital = .12+.10 X.57 =.177 that is 17.7% (2) calculation of after tax WACC company is financed by 47% of debt ,so the equity portion is 53% after taxed cost of debt =12%-12%*30% =8.4% Cost of equity=17.7% there for WACC =( 47% X8.4%)+(53% X17.7%) =13.329 %
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