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Acetate, Inc., has equity with a market value of $22.8 million and debt with a market...

Acetate, Inc., has equity with a market value of $22.8 million and debt with a market value of $6.84 million. The cost of debt is 9 percent per year. Treasury bills that mature in one year yield 5 percent per year, and the expected return on the market portfolio is 12 percent. The beta of Acetate’s equity is 1.13. The firm pays no taxes.

a. What is Acetate’s debt-equity ratio? (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).) Debt–equity ratio =?

b. What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).) Weighted average cost of capital = %?

c. What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).) Cost of capital =%?

Solutions

Expert Solution

Answer a.

Market Value of Debt = $6.84 million
Market Value of Equity = $22.80 million

Debt-equity Ratio = Market Value of Debt / Market Value of Equity
Debt-equity Ratio = $22.80 million / $6.84 million
Debt-equity Ratio = 3.33

Answer b.

Cost of Debt = 9%

Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 5% + 1.13 * (12% - 5%)
Cost of Equity = 12.91%

Market Value of Debt = $6.84 million
Market Value of Equity = $22.80 million

Total Value of Firm = Market Value of Debt + Market Value of Equity
Total Value of Firm = $6.84 million + $22.80 million
Total Value of Firm = $29.64 million

Weight of Debt = $6.84 million / $29.64 million
Weight of Debt = 0.2308

Weight of Equity = $22.80 million / $29.64 million
Weight of Equity = 0.7692

WACC = Weight of Debt*Cost of Debt + Weight of Equity*Cost of Equity
WACC = 0.2308*9% + 0.7692*12.91%
WACC = 12.01%

Answer c.

Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 5% + 1.13 * (12% - 5%)
Cost of Equity = 12.91%

jeff jeffy answered 2 years ago
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