Question

Company A has an unlevered beta equal to 1.2. The company has a debt equal to $20,000,000 and a levered beta equal to 1.9. Assume we have perfect competitive markets and there is no taxation. If the risk free rate is 2.00% and the expected return of the market portfolio is 6.00%, what is the company’s wacc? A. 6.80% B. 7.27% C. 8.00% D. 9.60% ANSWER IS 6.80% PLEASE DO NOT ANSWER UNLESS ARRIVE AT THIS, THANK YOU.

Answer 1

Levered Beta = B(l) = 1.9 , Unlevered Beta = B(u) = 1.2 and Tax Rate = 0

Let the Debt to Equity Ratio be D/E

Therefore, B(l) = B(u) x [1+ D/E]

1.9 = 1.2 x [1+D/E]

0.58333 = D/E

Further, as perfectly competitive markets is an assumption, the company's debt should be assumed to be risk-free.Hence, the cost of debt should be equal to the risk free rate (Rf) of 2 %

Maket Portfolio Return = Rm = 6 %

Cost of Equity = k(e) = Rf x B(l) x (Rm - Rf) = 2 + 1.9 x (6 - 2) = 9.6 %

Cost of Debt = k(d) = 2 %

Therefore, company WACC = 9.6 x [E / (D+E)] + 2 x [D / (D+E)] = 9.6 x (1/1.58333) + 2 x (0.58333/1.58333) = 6.80001 % or 6.8% approximately.

Hence, correct option is (A).