Question

Ganado and Equity Risk Premiums.  Maria​ Gonzalez, Ganado's Chief Financial​ Officer, estimates the​ risk-free rate to be

3.40%​,

the​ company's credit risk premium is

3.70%

the domestic beta is estimated at

0.99

the international beta is estimated at

0.76

and the​ company's capital structure is now

55​%

debt. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is

7.80​%

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.

8.40​%

b.

7.50​%

c.

5.30​%

d.

4.40​%

the domestic beta is estimated at

0.990.99​,

the international beta is estimated at

0.760.76​,

and the​ company's capital structure is now

5555​%

debt. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is

7.807.80​%

and the​ company's effective tax rate is

3939​%.

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

a.

8.408.40​%

b.

7.507.50​%

c.

5.305.30​%

d.

4.404.40​%

Answer 1

Using the CAPM formula we would calculate cost of equity as shown below
Cost of equity (Ke)	Rf + Beta*(Rm-Rf)
Risk free rate is Rf
Market return is Rm
Rm-Rf is risk premium
Weighted average cost of capital	(We*Ke + Wd*Kd)
We is weight of equity
Ke is cost of equity
Wd is weight of debt
Kd cost of debt
Calculate CAPM and ICAPM if risk premium is 8.40%
	CAPM	ICAPM
We	45%	45%
Wd	55%	55%
Cost of equity	11.716%	9.784%
	3.40%+(0.99*8.40%)	3.40%+(0.76*8.40%)
Cost of debt	4.758%	4.758%
	7.80%*(1-0.39)	7.80%*(1-0.39)
WACC	7.8891%	7.0197%
	(11.716%*0.45)+(4.758%*0.55)	(9.784%*0.45)+(4.758%*0.55)
Calculate CAPM and ICAPM if risk premium is 7.50%
	CAPM	ICAPM
We	45%	45%
Wd	55%	55%
Cost of equity	10.825%	9.100%
	3.40%+(0.99*7.50%)	3.40%+(0.76*7.50%)
Cost of debt	4.758%	4.758%
	7.80%*(1-0.39)	7.80%*(1-0.39)
WACC	7.4882%	6.7119%
	(10.825%*0.45)+(4.758%*0.55)	(9.100%*0.45)+(4.758%*0.55)
Calculate CAPM and ICAPM if risk premium is 5.30%
	CAPM	ICAPM
We	45%	45%
Wd	55%	55%
Cost of equity	8.647%	7.428%
	3.40%+(0.99*5.3%)	3.40%+(0.76*5.3%)
Cost of debt	4.758%	4.758%
	7.80%*(1-0.39)	7.80%*(1-0.39)
WACC	6.5081%	5.9595%
	(8.647%*0.45)+(4.758%*0.55)	(7.428%*0.45)+(4.758%*0.55)
Calculate CAPM and ICAPM if risk premium is 4.40%
	CAPM	ICAPM
We	45%	45%
Wd	55%	55%
Cost of equity	7.756%	6.744%
	3.40%+(0.99*4.4%)	3.40%+(0.76*4.4%)
Cost of debt	4.758%	4.758%
	7.80%*(1-0.39)	7.80%*(1-0.39)
WACC	6.1071%	5.6517%
	(7.756%*0.45)+(4.758%*0.55)	(6.744%*0.45)+(4.758%*0.55)