Question

Maxwell Electronics, a consumer electronics company, plans to expand its operations in the Asia‐Pacific region. The company has debt of $4 million and assets worth $14 million. Cuprum Electricals Inc., the market leader, has similar revenue, net income, and business risk.

The information of the two companies is as follows:

Debt of Cuprum Electricals Inc. $7 million Equity of Cuprum Electricals Inc. $35 million Levered beta of Cuprum Electricals Inc. 0.8 Marginal tax rate 40% Risk‐free rate 5% Market risk premium 10% Based on the information provided, calculate the cost of equity of Maxwell Electronics.

Group of answer choices

10.76%.

13.86%.

13.37%.

Answer 1

Calculation of unlevered beta of Cumprum
Unlevered Beta	Levered beta/(1+(1-tax rate))*Debt-equity ratio
Unlevered Beta	0.80/(1+(1-0.40)*(7/35))
Unlevered Beta	0.80/1+(0.12)
Unlevered Beta	0.80/(1.12)
Unlevered Beta	0.7143
Value of equity of maxwell	14-4
Value of equity of maxwell	$10.00	million
Calculation of unlevered Beta of Maxwell electronics
Unlevered Beta	Comparable beta*(1+(1-tax rate))*Debt-equity ratio
Unlevered Beta	0.7143*(1+(1-0.40)*(4/10))
Unlevered Beta	0.7143*1.24
Unlevered Beta	0.8857
Using CAPM model we would calculate cost of equity
Cost of equity	Risk free rate + Beta*Market risk premium
Cost of equity	0.05 + (0.8857*0.10)
Cost of equity	0.05+0.08857
Cost of equity	13.86%
Thus, cost of equity is 13.86%