Question

Mackenzie Company has a beta of 1.2, the risk-free rate is 3.5%, and it estimates the...

Mackenzie Company has a beta of 1.2, the risk-free rate is 3.5%, and it estimates the market risk premium to be 6%. It has a cost of debt of 6%, and is financed 70% with equity and 30% with debt. Mackenzie’s tax rate is 21%. Estimate the equity cost of capital for Mackenzie. What is this firm's WACC?

The cost of equity is calculated using the Capital Asset Pricing Model (CAPM).

It is calculated using the formula below:

Ke=Rf+b[E(Rm)-Rf]

Where:

Rf=risk-free rate of return

Rm=expected rate of return on the market.

b= stock’s beta

Ke= 3.5% + 1.2*6%

= 3.5% + 7.20% = 10.70%.

Weighted Average Cost of Capital (WACC) is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

Where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC= 0.30*6%*(1-0.21) + 0.70*10.70%

= 0.30*4.74% + 0.70*10.70%

= 1.42% + 7.49% = 8.91%.

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