A firm has a capital structure containing 60 percent debt and 40 percent common stock equity. Its outstanding bonds offer investors a 6.5 percent yield-to-maturity.
The risk-free rate currently equals 5 percent, and the expected risk premium on the market portfolio equals 6 percent. The firm's common stock beta is 1.20.
a. What is the firm's required return on equity?
b. Ignoring taxes, use your finding in part (a) to calculate the firm's WACC.
c. Assuming a 40 percent marginal tax rate, recalculate the firm's WACC found in part (b).
d. Compare and contrast the values for the firm's WACC found in parts (b) and (c).