Question

PLEASE answer using EXCEL. Add formulas and steps used. Thank you!

5. A company is 42% financed by risk-free debt. The interest rate is 12%, the expected market risk premium is 10%, and the beta of the company’s common stock is 0.52.

What is the after-tax WACC, assuming that the company pays tax at a 40% rate.

Answer 1

Given the following,

42% financed by risk free debt = D/V = 42% = 0.42

Expected market risk premium = 10% = 0.1

Beta = 0.52

tax rate = 40% = 0.4

Since the debt is risk free debt the risk free rate and cost of debt are equal

Rf = Rd = 12% = 0.12

WACC can be caluculated by the following formula,

WACC = (D/V)*(1-t)*Rd + Re*(E/V)

Where

Re = cost of equity

Rd = cost of debt

t = corporate tax rate

E = market value of equity

D = market value of debt

V = E+D

D/V = 0.42

E/V = (1-0.42) = 0.58

Step 1:

Calculating for Re using CAPM(capital asset pricing model) formula,

Re = Rf+B*Rm

Thus Re = 0.172 = 17.2%

Step 2:

Using Re to calculate after tax WACC

Calculating after tax WACC using the given values,

Therefore, after tax WACC is 0.13 or 13%