Question

Calculate the following:

The cost of equity if the risk-free rate is 2%, the market
risk premium is 8%, and the beta for the company is 1.3.

The cost of equity if the company paid a dividend of $2 last
year and is expected to grow at a constant rate of 7%. The stock
price is currently $40.

The weighted average cost of capital (WACC) if the company has
a total value of $1 million with a market value of its debt at
$600,000 and a market value of its equity at $400,000. Its cost of
debt is 6% and its cost of equity is 15%. The tax rate it pays is
25%.

Answer #1

Answer a.

Risk-free Rate = 2%

Beta = 1.30

Market Risk Premium = 8%

Cost of Equity = Risk-free Rate + Beta * Market Risk
Premium

Cost of Equity = 2% + 1.3 * 8%

Cost of Equity = 12.40%

Answer b.

Last Year Dividend, D0 = $2

Growth Rate, g = 7%

Stock Price, P0 = $40

Cost of Equity = D0*(1 + g) / P0 + g

Cost of Equity = $2*1.07 / $40 + 0.07

Cost of Equity = 12.35%

Answer c.

Weight of Debt = Value of Debt / Value of Firm

Weight of Debt = $600,000 / $1,000,000

Weight of Debt = 60%

Weight of Equity = Value of Equity / Value of Firm

Weight of Equity = $400,000 / $1,000,000

Weight of Equity = 40%

WACC = Weight of Debt * Cost of Debt * (1 - tax) + Weight of
Equity * Cost of Equity

WACC = 60% * 6% * (1 - 0.25) + 40% * 15%

WACC = 8.70%

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