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Geronimo Corp is financed 60% with equity and 40% with debt.Currently, its debt has a...

Geronimo Corp is financed 60% with equity and 40% with debt. Currently, its debt has a before-tax yield to maturity of 5%. Geronimo's common stock has a beta of 1.75 and market risk premium is 8% while risk free rate is 1%. If the tax rate is 40%, what is Geronimo's weighted average cost of capital (WACC)?

A. 7.40%
B. 7.83%
C. 10.20%
D. 9.00%
E. 11.47%

Expert Solution

After tax cost of debt = 5 * ( 1 – 0.40)

= 5 * 0.60

= 3%

As per CAPM

Expected return = R_f + Beta * ( R_m – R_f)

R_f = Risk free rate = 1%

Beta = 1.75

Market risk premium = R_m – R_f = 8%

Expected return = 1% + 1.75 ( 8%)

= 1% + 14%

= 15%

cost of equity is 15%

Calculation of Geronimo’s weighted average cost of capital ( WACC)

Particulars	Weights	Cost of capital	WACC
Debt	0.4	3%	1.2
Common stock	0.6	15%	9
Total			10.2%

WACC = weights * cost of capital

The Geronimo’s weighted Average cost of capital is 10.20%

so, the correct answer is C 10.20%

jeff jeffy answered 2 years ago

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