Question

(A) Please calculate the Weighted Average Cost of Capital (WACC) for the following company. Assumptions:

Risk free rate = 4.0%

Company’s spread = 2.0%

Expected return of the market = 9.0%

Company Beta = 1.10

Company debt to capitalization ratio = 40%

Company tax rate = 30%.

(Please be sure to show your calculations.) (B) Please define and explain the Hurdle Rate. (3 points)

Answer 1

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Answer:

a)

After tax cost of debt = Debt rate * (1-tax)

(4% + 2%)*( 1 - 0.3) = 4.20%

cost of equity = Rf + beta (Rm - Rf)

4% + 1.10*(9% - 4%) = 9.50%

WACC = Debt wgt* After tax debt + Equity weight* Ke

0.4*4.2% + 0.6*9.50% = 7.38%

b)

Hurdle rate is defined as the minimum rate (above required rate of return)  that a company expects for investing in a particular project. For a project to be taken by the company, IRR must atleast meet or be more than the hurdle rate. Usually the projects with higher risk has a high hurdle rate as the return expected also wil be higher by the investors for investing in that particular project