Question

1. Bug Zapper corporation (BZC) is a defensive utility stock with a Beta of 0.5. The market expected return is 14% and the risk free rate is 10%. In addition, we know that BZC faces a corporate tax rate of 25% and it maintains a debt to value ratio of 0.4. BZC's debt cost of capital is 10%. Please estimate BCZ's rwaac

   	a.	8.20%
   	b.	12.00%
   	c.	11.20%
   	d.	10.20%

Answer 1

- As per CAPM,

where, rf = Risk free return = 10%

Rm = Market Return = 14%

beta of Stock = 0.5

Required rate of Return = 10% +0.5(14% - 10%)

Required rate of Return = 12%

So, Required rate of Return or Cost of equity = 12%

- Debt to Value ratio is 0.40 which means Debt is 40% in total Capital Structure. Thus, equity will be 60% in total Capital structure.

Calculating WACC:-

WACC= (Weight of Debt)(Cost of Debt)(1-Tax Rate) + (Weight of Equity)(Cost of Equity)

WACC = (0.40)(10%)(1-0.25) + (0.60)(12%)

WACC = 3% + 7.2%

WACC = 10.20%

So, estimate BCZ's rwaac is 10.20%

Option D

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