Question 1 WACC
_ Step 1. Calculate the value of each security as a proportion of the firm’s market value – i.e. D/(D+E); E/(D+E), etc.
_ Step 2. Determine the required rate of return on each security – i.e. Rd for debt, Re for equity, etc (make sure you calculate after-tax cost of debt).
_ Step 3. Calculate a weighted average after tax return on the debt and the return on the equity – i.e. WACC.
Applying the Three-Step approach to compute WACC above, compute the WACC using the following information.
Hint: Review Class #6 – Part 2, including the WACC.
PART 1
Debt = 60m; Equity = 40m. Riskfree rate (Rf) = 4%, Beta = 0.85, Expected market return (Rm) = 10%. Cost of Debt (Rd) = 5.5%. Corporate Tax Rate (tax) = 35%. Compute the firm’s WACC using the Three-Step approach above
PART 2
Debt = 40m; Equity = 60m. Riskfree rate (Rf) = 4%, Beta = 1.95, Expected market return (Rm) = 10%. Cost of Debt (Rd) = 7.5%. Corporate Tax Rate (tax) = 35%. Compute the firm’s WACC using the Three-Step approach above
PART 3
Debt = 0m; Equity = 100m. Riskfree rate (Rf) = 4%, Beta = 1.25, Expected market return (Rm) = 10%. Compute the firm’s cost of capital using the Three-Step approach above.