Question

Ganado and Equity Risk Premiums. Maria? Gonzalez, Ganado's Chief Financial? Officer, estimates the? risk-free rate to be 3.70%?,the? company's credit risk premium is 4.10?%,the domestic beta is estimated at 1.01?,the international beta is estimated at 0.68?,and the? company's capital structure is now 30?% debt. The? before-tax cost of debt estimated by observing the current yield on? Ganado's outstanding bonds combined with bank debt is8.10?% and the? company's effective tax rate is 39?%. Calculate both the CAPM and ICAPM weighted average costs of capital for the following equity risk premium estimates.

a.8.10?%

b.7.20?%

c.5.20?%

d.4.10?%

Answer 1

Assumptions CAPM ICAPM
Ganado beta, ?                        1.01                        0.68
Risk-free rate of interest, krf 3.70% 3.70%
Company credit risk premium 4.10% 4.10%
Cost of debt, before tax, kd 8.10% 8.10%
Corporate income tax rate, t 39% 39%
Equity risk premium 8.10% 8.10%
General return on market portfolio, km 12.00% 12.00%
Optimal capital structure:
     Proportion of debt, D/V 30% 30%
     Proportion of equity, E/V 70% 70%

a) Ganado cost of equity 12.083% 9.344%
      ke = krf + ( km - krf ) ?

b) Ganado cost of debt, after tax 4.941% 4.941%
      kd x ( 1 - t )

c) Ganado weighted average cost of capital 9.940% 8.0231%
     WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ]   

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for 7.20

c) Ganado weighted average cost of capital		9.233%		7.5471%
WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ]

for 5.20

c) Ganado weighted average cost of capital		7.819%		6.5951%
WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ] for 4.10 c) Ganado weighted average cost of capital 7.112% 6.1191%      WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ]