Question

The CFO of Anthem Insurance company is preparing for the budgeting discussions presented by each business unit in the company. She knows that she will need some idea of the company's cost of capital to fund these projects in order to evaluate and compare the options. Anthem's cost of capital depends primarily upon...

a. total assets reported in company's financial statements.

b. the nature of the company's business (operating risk)

c. the amount of debt financing (leverage) it choses to utilize (financing risk)

d. b. only

e. both a. & b.

f. both b. & c.

Answer 1

Answer:

Correct answer is:

f. both b. & c

Explanation:

WACC = Cost of equity * Equity / (Equity + Debt) + Before tax cost of debt * (1 - Tax rate) * Debt / (Equity + Debt)

Cost of Equity = Risk free rate + Beta * Market Risk premium

From input variables as given above which are determinants of WACC, it is clear that Cost of capital (WACC) depends primarily upon:

1. the amount of debt financing (leverage) that it chose to utilize (financing risk)

2. the nature of the company's business (operating risk)

As such option f is correct and other options a,b,c