Question

Pharoah Resources Company has a WACC of 13.5 percent, and it is subject to a 40...

Pharoah Resources Company has a WACC of 13.5 percent, and it is subject to a 40 percent marginal tax rate. Pharoah has $230 million of debt outstanding at an interest rate of 10 percent and $750 million of equity (at market value) outstanding. What is the expected return on the equity with this capital structure? (Round answer to 2 decimal places, e.g. 17.54%.)

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Answer #1

Total value = $230 million + $750 million = $980 million

WACC = (Weight of common stock * Cost of common equity) + [Weight of debt * Pretax cost of debt(1 - Tax)]

0.135 = [($750 million/$980 million) * Cost of common equity) + [($230 million/$980 million) * 0.10(1 - 0.40)]

0.135 = (0.7653 * Cost of common equity) + 0.01408

0.7653 * Cost of common equity = 0.135 - 0.01408

0.7653 * Cost of common equity = 0.12092

Cost of common equity = 0.12092 / 0.7653

Cost of common equity = 0.1580 or 15.80%

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