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In: Finance

The current market rate of return is 12% and the risk-free rate is 4%. You have...

The current market rate of return is 12% and the risk-free rate is 4%. You have been given the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. a. What is the market value of firm and the debt respectively? b. What is the required rate of return on equity? c. What is the firm's WACC?

Solutions

Expert Solution

Shares O/s=       1,000,000.00
Current value 22.5
Equity capital     22,500,000.00 (22.5*1000000)
Equity as a % of capital structure= 70% (Since debt is 30%)
So total capital = 32142857.14 22500000/70%
debt=       9,642,857.14 (32142857.14-22500000)
So market value of firm is $ 32,142,857.14
debt= $   9,642,857.14
As per CAPM
Required rate of return= Rf + (Rm-Rf)*Beta
Rf=Risk free interest Rf=4% Rm=12% Beta=1.40
Rm=market return
Required rate of return(%)= 4+(12-4)*1.4
15.2
After tax cost of debt= 8.4 (12*70%)
Computation of WACC
Market Value
Particulars Cost Weights Amount
Equity 15.2%                    0.70     22,500,000.00
debt 8.40%                    0.30       9,642,857.14
1    32,142,857.14
WACC(%) 13.16
(0.70*15.2)+(0.30*8.40)
WACC= weight of equity *cost of equity+weight of debt*cost of debt

jeff jeffy answered 1 year ago
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