Problem:
Amgel Manufacturing Company's current capital structure is comprised of 30% debt and 70% equity (based on market values). Amgel's equity beta (based on its current level of debt financing) is 1.20, and its debt beta is 0.29. Also, the risk-free rate of interest is currently 4.5% on long-term government bonds. Amgel's investment banker advised the firm that, according to its estimates, the market risk premium is 5.25%.
Q1. What is your estimate of the cost of equity capital of Amgel (based on the CAPM)?
Q2. If Amgel's marginal tax rate is 35%, what is the firm's overall weighted average cost of capital (WACC)?
Q3. Amgel is considering a major expansion of its current business operations. The firm's investment banker estimates that Amgel will be able to borrow up to 40% of the needed funds and maintain its current credit rating and borrowing cost. Estimate the WACC for this project.