Question

Automatic Data Processing has a beta of 2.67 and the expected market return is 0.16. If Treasury bills are currently yielding 0.03 percent, find the cost of capital for Automatic Data Processing (round your answers).

none of the answers is correct

39.9%

27.5%

37.7%

34.1%

Calculate WACC given the following information (BT means before tax).

Total Value of Common Stocks (S)	$1,000,000	Cost of Equity (common stocks, Ks)	22%
Total Value of Preferred Stocks (P)	$200,000	Cost of Preferred stock (Kp)	12%
Total Value of Debt (D)	$300,000	Before Tax Cost of Debt (BT Kd)	9%
		Tax rate (T)	30%

none of the answers is correct

17.53%

9.86%

20.10%

19.72%

Answer 1

1.Information provided:

Beta= 2.67

Expected market return= 0.16

Risk free rate= 0.03

The cost of equity is calculated using the Capital Asset Pricing Model (CAPM).

The formula for calculating the capital asset pricing model is given below:

Ke=Rf+b[E(Rm)-Rf]

where:

Rf=risk-free rate of return

Rm=expected rate of return on the market.

B= Beta of the company

Ke= 0.03 + 2.67*(0.16 – 0.03)

     = 0.03 + 0.3471

     = 0.3771*100

     = 37.71%.

The answer is option c.

2.Total firm capital= $1,000,000 + $200,000 + $300,000

                       = $1,500,000.

Weight of equity in the capital structure= $1,000,000/ $1,500,000

                                                                          = 0.67*100

                                                                          = 67%

Weight of debt in the capital structure= $300,000/ $1,500,000

                                                                          = 0.20*100

                                                                          = 20%

Weight of preference shares in the capital structure=$200,000/ $1,500,000

                                                                                                    = 0.13*100

                                                                                                    = 13%

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= The before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= The cost of common equity.

T= Tax rate

WACC= 0.20*9%*(1 – 0.30) + 0.13*12% + 0.67*22%

            = 1.26% + 1.56% + 14.74%

            = 17.56%.

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