Acetate, Inc., has equity with a market value of $23.5 million and debt with a m

Question

Acetate, Inc., has equity with a market value of $23.5 million and debt with a market value of $11.75 million. The cost of debt is 8 percent per year. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio is 10 percent. The beta of Acetate’s equity is 1.2. The firm pays no taxes.

  

  

  

What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

  

  

What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

  

Acetate, Inc., has equity with a market value of $23.5 million and debt with a market value of $11.75 million. The cost of debt is 8 percent per year. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio is 10 percent. The beta of Acetate’s equity is 1.2. The firm pays no taxes.

Explanation / Answer

a. cost of equity = 4 + 6 *1.2 = 11.20%

b.

WACC = 10.13%

c. beta unlevered = 1.2/(1 + 1/2) = 0.80

cost of equity or WACC = 4 + 6*0.8 = 10.80%

Market value weight cost weight*cost equity 23.5 0.6667 11.20% 0.0747 debt 11.75 0.3333 8.00% 0.0267

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