Question

Ganado's Cost of Capital.  Maria​ Gonzalez, Ganado's Chief Financial​ Officer, estimates the​ risk-free rate to be 3.40 %​, the​ company's credit risk premium is 4.20​%, the domestic beta is estimated at 1.12​, the international beta is estimated at 0.88​, and the​ company's capital structure is now 25​% debt. The expected rate of return on the market portfolio held by a​ well-diversified domestic investor is 9.60​% and the expected return on a larger globally integrated equity market portfolio is 8.60 %. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is 8.00​% and the​ company's effective tax rate is 38​%. For both the domestic CAPM and​ ICAPM, calculate the​ following: a.​ Ganado's cost of equity b.​ Ganado's after-tax cost of debt c.​ Ganado's weighted average cost of capital a. Using the domestic​ CAPM, what is​ Ganado's cost of​ equity?

Answer 1

a. Domestic cost of equity = Risk free return + beta * ( Expected return -risk free return)

= 3.4% + 1.12*(9.6%- 3.4%) = 10.34%

International cost of equity =Risk free return + beta * ( Expected return -risk free return)

= 3.4% + 0.88*(8.6%- 3.4%) = 7.98%

b. After tax cost of debt = 8%* (1-38%) = 4.96%

c.

Domestic CAPM
	Weights	Cost	Weights *Cost
Debt	0.25	4.96%	1.24%
Equity	0.75	10.34%	7.76%
WACC			9.00%
International CAPM
	Weights	Cost	Weights *Cost
Debt	0.25	4.96%	1.24%
Equity	0.75	7.98%	5.98%
WACC			7.22%