Question

Homework:

12) You are trying to calculate the weighted average cost of capital for investment property group in San Francisco, CA. The owners secured a loan at a 6 percent rate and are in a 15 percent tax bracket. The property has initial investment of $22,00,000. We can assume that the net cash flow for 2019 of $543,000 will remain the same until 2029, after which it drops to zero dollars. You are provided with the following information for cost of capital: Beta (B) = 2.2, their loan carries a 1 percent default risk premium over 10 year treasury bonds, they have $400,000 in equity to invest in the project, analysts expect the S&P 500 to return 10 percent per year through 2029.

Please show the work, I am so lost on

Answer 1

Weight of equity = equity/project investment = 400000/2200000=0.1818

Weight of debt = 1-weight of equity = 1-0.1818=0.8182

Risk free rate = t bond rate = cost of debt-default risk premium = 6-1 = 5%

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 5 + 2.2 * (10 - 5)

Cost of equity% = 16

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

After tax cost of debt = 6*(1-0.15)

= 5.1

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=5.1*0.8182+16*0.1818

WACC =7.08%