Question

Given the following information please find the implied beta (leveraged) for the firm, and then calculate the new leveraged beta and the new WACC if the firm borrows additional $1250 Million

Market value of equity	1,000
Market value of debt	3000
Cost of equity capital in US dollars =	9.20%
Risk Free rate	5%
ERP	3%
Interest Rate on Debt	6%
Tax Rate	40%

Hint: use cost of equity capital to get implied leveraged beta, use it to calculate unleveraged beta, recalculate the leveraged beta after adding new debt, calculate new weights on debt and equity and the new WACC.

Answer WACC

a.              15.20%

b.              10.80%

c.              4.90%

d.              2.92%

Answer 1

Cost of equity capital=Riskfree+(beta*ERP)
9.2%=5%+bets*3%
beta=1.4
Leveraged beta=unleveraged beta*(1+(d/e)*(1-tax))
1.4=unleveraged*(1+(3000/1000)*(1-40%))
Unleveraged beta=0.5

WACC=(wt of debt*cost of debt)+(wt of equity*cost of equity)

debt=3000+1250=4250
equity=1000
total=4250+1000=5250
wt of debt=(4250/5250)=80.95%
wt of equity=1-80.95%=19.05%

Cost of debt=6%*(1-40%)=3.6%
Leveraged beta new= 0.5*(1+(4250/1000)*(1-40%))
=1.775
Cost of equity=5%+(1.775*3%)=10.33%
WACC=(80.95%*3.6%)+(19.05%*10.33%)=4.90%
it is option C