Question

Anker Inc. is a listed company in New York. Its current before interest after-tax operating cash flow is $100 million. The cash flow is expected to grow at 6% per annum over the next three years, after which the growth will fall to 3% per annum and stay at this rate forever. The following information is also available:

Tax rate	30%
Risk-free rate	4%
Market return	12%
Equity beta	2
Cost of debt	7%
D/E	60%

Given the above data, Anker Inc.’s cost of equity is around:

	A.	15%
	B.	25%
	C.	20%
	D.	8%

2.

Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The tax rate is 30%. The firm is funded $50,000 of debt and $150,000 of equity. The cost of equity is 18% and the cost of debt is 6%.

Given the information above, what is the appropriate discount rate if earnings after interest and before tax (EAIBT)is used to calculate the equity value of the firm?

	A.	20.79%
	B.	25.71%
	C.	18%
	D.	14.55%
	E.	None of the above

Answer 1

1. Cost of equity using CAPM Equation = Risk Free + Beta * Market return - Risk Free)

Cost of equity using CAPM Equation = 4% + 2 *(12% - 4%)

Cost of equity using CAPM Equation = 20% Option C

2. when the amount is earnings after interest before tax, we have to calculate the discount rate by dividing cost of equity by (1 - Tax)

Discount rate = Cost of equity / (1 - Tax)

Discount rate = 18% / 0.70

Discount rate = 25.71% Option B