Question

Company Y has common stock beta 1.4. Risk free rate is 5% and market risk premium is 8%. Company Y cost of debt is 5,4%. Company tax rate is 35%. Debt to equity ratio is 0.6.

Calculate E/V ratio. Express your answer as %.

Answer 1

Cost of equity capital = Risk free rate + Beta x Market risk premium

= 5% + 1.4 x 8%

= 5% + 11.2%

= 16.2%

E/V ratio is basically weight of equity relative to total value of assets i.e. Debt + Equity, so here Debt equity ratio is just 0.6 that is to say debt is just 60% of equity 100%, using that conception

E/V ratio = Equity/(Debt + Equity)

= 1/(0.6+1)

= 1/1.6

Or 0.625 i.e. 62.50% Ans

We can calculate WACC using this information

WACC = E/V x re + D/V x rd (1-tax)

WACC = 62.5% x 16.2% + 37.5% x 5.4% x (1-0.35)

WACC = 10.125% + 1.31625%

WACC = 11.44%