Health Services Corporation (HSC) is capitalized with 10 million dollars in debt

Question

Health Services Corporation (HSC) is capitalized with 10 million dollars in debt at 7% and an additional 15 million in Equity for which investors expect a 20% rate of return. If the company’s tax rate is 40%, what is HSC’s weighted average cost of capital?

Premier Care Corporation (PCC) has long term debt at 5% in the amount of $20 million. Equity totals $30 million. PCC’s marginal tax rate is 40%, and the commonly used beta for the industry is 1.2 while government securities are paying 2%. The market returns 9% on average. What is XYZ’s weighted average cost of capital using the Capital Asset Pricing Method?

A given firm’s beta is .7 (a little on the safe side); risk free rates are 2%; and the market, in general, returns 8%. The company has $20 million in debt and $15 million in equity where the interest rate on the debt is 7% and tax rate is 35%. Using the Capital Asset Pricing Method for determining the cost of equity, what is the firm’s weighted average cost of capital?

Explanation / Answer

Weighted average cost of capital = weight of debt* cost of debt + weight of equity* cost of equity

= 10/25*(7%- 40% tax) + 15/25* (20%) = 4.6%+ 12% = 16.6%

using CAPM, Required rate of return = risk free rate + (market return - risk free return)*beta

                                                     = 2 + (9-2)*1.2 = 10.4%

Weighted Cost of capital = 20/50 * (5% - 40% tax) + 30/50 * (10.4%)

                                     = 1.2 +6.24 = 7.44%

Capital Asset pricing model = 2% + (8% - 2%)*0.7 = 6.2%

Weighted average cost of capital = 20/35 * (7% - 35% tax) + 15/35 * ( 6.2%) = 5.25%

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