Jet Taxi is wholly owned by Western Holdings, a global tourism company. Western
ID: 2805005 • Letter: J
Question
Jet Taxi is wholly owned by Western Holdings, a global tourism company.
Western Holdings is publicly traded and its equity beta is 2. The equity beta for Jet Taxi is not observable because the entity’s stock is not publicly traded. There are, however, a number of publicly traded air taxi companies. The data for two such companies are given below. The Jet taxi operations are 50% equity financed and have a marginal tax rate of 40%. The cost of borrowing for Jet Taxi is 6%. At the present time, the long-term U.S. Treasury bond rate is 5%. Based on historical data, most analysts believe that a reasonable estimate of the market risk premium (i.e., Rm – rf) is 7.5%.
In order to value Jet Taxi CEO Goldstein needs an estimate of WACC for Jet Taxi.
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
What is the WACC for Jet Taxi
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
Explanation / Answer
First lets calculate the required rate of return of equity (Re) for Jet Taxi. We are going to use the CAPM model:
Re = Rf + B(Rm-Rf)
Jet Taxi’s capital structure is similar to Levent Jets with 50 % equity and 50 % debt. Hence, we would use the same Beta (B) for Jet Taxi as that of Levent Jet’s , 2.
Re = 5 + 2×7.50
= 20%
(Note: We are given Rf as 5 %, and Rm-Rf as 7.5%)
We know the cost of debt (Rd) to be 6%.
Therefore, WACC:
Rd (1-T) (D/V)+Re (E/V)
Where T= Marginal Tax Rate
D/V= Proportion of debt
E/V= Proportion of equity
WACC= 6(1-0.40)(0.50)+20(0.50)
= 1.8+10
=11.8%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.