Thunderhorse Oil is a U.S. oil company. Its current cost of debt is 7%, and the 10-year U.S. Treasury yield, the proxy for the riskfree rate of interest, is 3%. The expected return on the market portfolio is 8%.The company’s effective tax rate is 39%. Its optimal capital structure is 60% debt and 40% equity. Use Houston’s beta at 1.25 to calculate its weighted average cost of capital!
a. If Houston’s beta is estimated at 1.25, what is Houston’s weighted average cost of capital?
b. If Houston’s beta is estimated at 0.8, significantly lower because of the continuing profit prospects in the global energy sector, what is Houston’s weighted average cost of capital?