Question

The Bonnie Situation Int'l Inc. currently has 60 percent debt in its capital structure, the corporate...

The Bonnie Situation Int'l Inc. currently has 60 percent debt in its capital structure, the corporate tax rate is 0.35 and the before tax cost of debt, rd, is the same as the risk‑free rate. Given the following market parameters,

              rm = 9% , rf =3.75% , ßL = 1.07

Find the cost of equity, the weighted average cost of capital, the operating risk, i.e., ßu , the cost of equity if The Bonnie Situation Int'l Inc. were unlevered.

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Homework Answers

Answer #1

Cost of equity = Risk free rate + Beta* (Market return - Risk Free Rate) = 3.75% + 1.07*(9%-3.75%) = 9.37%

WACC = Weight of Debt * Cost of Debt*(1-Tax Rate)+ Weight of Equity * Cost if Equity = 60%*3.75%*(1-0.35)+40%*9.37% =5.21%

Cost of Unlevered Beta = Beta Levered/(1+(1-Tax Rate)*Debt/Equity) = 1.07/(1+(1-0.35)*60%/40%) = 0.5418

Cost of equity(operational Risk) = Risk free rate + Beta* (Market return - Risk Free Rate) = 3.75% + 0.5418*(9%-3.75%) = 6.59%

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