Task: ABC company currently has the following capital structure: 30% debt and 70% equity based on market values. Company's equity beta based on its current level of debt financing is 1.20 and its debt beta is 0.30. Risk free rate of interest is currently 2.5% on long-term government bonds. The company's pre-tax cost of debt is 5%. The market risk premium is 7.5%.
Problem 1. What is your estimate of the cost of equity capital for the company based on the CAPM?
Problem 2. If company's marginal tax rate is 35%, what is the firm's overall weighted average cost of capital?
Problem 3. The company considers acquiring a Solar Energy arm to expand its current business operations. The new division will be relatively independent and it will issue its own debt constituting 45% of total assets of the division. Nevertheless, the firm's investment banker estimates that the company will be able to and maintain its current credit rating and borrowing cost. Analysts usually report that unlevered betas in all energy sectors are the same. Estimate the WACC for the division.