Question

 Maria​ Gonzalez, Ganado's Chief Financial​ Officer, estimates the​ risk-free rate to be 3.00%​, the​ company's credit risk premium is 4.20​%,

the domestic beta is estimated at 0.94​, the international beta is estimated at 0.62​, and the​ company's capital structure is now

25​% debt. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is 8.00​% and the​ company's effective tax rate is 38​%.

Calculate both the CAPM and ICAPM weighted average costs of capital for the following equity risk premium estimates.

debt.

a. 8.20​%

b. 7.10​%

c. 4.90​%

d. 3.90​%

Answer 1

Working:

After tax cost of debt =Before tax cost of debt [1-tax rate]

                     = 8[1-.38]

                    = 8*.62

                    = 4.96%

If weight of Debt is 25% then cost of equity is = 100-25 =75%

As per CAPM ,cost of equity = risk free rate +[Beta *market risk premium]

cost of equity

Market risk premium	4.20%	8.20%	7.10%	4.90%	3.90%
cost of equity (Domestic)	3+[.94*4.20] 3+ 3.948 6.948%	3+[.94*8.20] 3+ 7.708 10.708%	3+[.94*7.10] 3+ 6.674 9.674%	3+[.94*4.90] 3+ 4.606 7.606%	3+[.94*3.90] 3+ 3.666 6.666%
International	3+[.62*4.20] 3+ 2.604 5.604%	3+[.62*8.20] 3+ 5.084 8.084%	3+[.62*7.10] 3+ 4.402 7.402%	3+ [.62*4.90] 3+ 3.038 6.038%	3+[.62*3.9] 3+ 2.418 5.418%

CALCULATION OF WACC

If Market risk premium = 4.20%

	DOMESTIC			INTERNATIONAL
	Weight	cost	weighted average cost of capital	Weight	cost	weighted average cost of capital
Before tax cost of capital	25%	4.96%	1.24	25%	4.96%	1.24
cost of equity	75%	6.948	5.21	75%	5.604	4.20
weighted average cost of capital			6.45%			5.44%

a)If Market risk premium = 8.20%

	DOMESTIC			INTERNATIONAL
	Weight	cost	weighted average cost of capital	Weight	cost	weighted average cost of capital
Before tax cost of capital	25%	4.96%	1.24	25%	4.96%	1.24
cost of equity	75%	10.708	8.03	75%	8.084	6.06
weighted average cost of capital			9.27%			7.30%

b)If Market risk premium = 7.10%

	DOMESTIC			INTERNATIONAL
	Weight	cost	weighted average cost of capital	Weight	cost	weighted average cost of capital
Before tax cost of capital	25%	4.96%	1.24	25%	4.96%	1.24
cost of equity	75%	9.674	7.26	75%	7.402	5.55
weighted average cost of capital			8.50%			6.79%

c)If Market risk premium = 4.90%

	DOMESTIC			INTERNATIONAL
	Weight	cost	weighted average cost of capital	Weight	cost	weighted average cost of capital
Before tax cost of capital	25%	4.96%	1.24	25%	4.96%	1.24
cost of equity	75%	7.606	5.70	75%	6.038	4.53
weighted average cost of capital			6.94%			5.77%

d)If Market risk premium = 3.90%

	DOMESTIC			INTERNATIONAL
	Weight	cost	weighted average cost of capital	Weight	cost	weighted average cost of capital
Before tax cost of capital	25%	4.96%	1.24	25%	4.96%	1.24
cost of equity	75%	6.666	5	75%	5.418	4.06
weighted average cost of capital			6.24%			5.30%