Question

Travelport Worldwide Limited is a U.S. firm that conducts major importing and exporting business in the U.K., whereby all transactions are invoiced in dollars. It obtained debt in the United States at an interest rate of 5 percent per year. The long-term risk-free rate in the United States is 3 percent. The stock market rate of return in the United States and the world stock market rate of return are respectively expected to be 9 percent and 13 percent annually. Travelport’s beta against the U.S. stock market and the beta against the world market are 1.5 and 0.5, respectively. Its target capital structure is 50 percent debt and 50 percent equity. Travelport Worldwide Limited is subject to a 20 percent corporate tax rate.

(a) (5 points) Suppose that the U.S. stock market is isolated from the world stock market. Estimate the cost of capital to Travelport Worldwide Limited using a domestic CAPM.

(b) (5 points) Now instead assume that the U.S. stock market is integrated to the world stock market. Estimate the cost of capital (WACC) to Travelport Worldwide Limited using an international CAPM.

Answer 1