A firm has a capital structure containing 60% debt and 40% common stock. its out

Question

A firm has a capital structure containing 60% debt and 40% common stock. its outstanding bonds offer investor a 6.5% yield to maturity. The risk-free rate currently equals 5% and the expected risk premium on the market portfolio equal 6%. The firm's common stock bet a is 1.20

(a) What is the firm's required return on equity?

(b) Ignoring taxes, use your finding in part (a0 to calculate the firm's WACC

(c) Assuming a 40% tax rate, recaculate the firms WACC found in part (b)

(d) Compare and contrast the values for the firm's WACC found in part (b) and (c)

Explanation / Answer

The firm required return on equity = 12.2%

=5+1.2 x6=12.2%

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Wacc=.6x6.5+.4x12.2=8.78%

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Wacct after =.6 x 6.5 x .6+.4x12.2=7.22%

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The after tax WACC of the company is lower that its before tax wacc due to tax shield created from using debt

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