Acetate, Inc., has equity with a market value of $23.1 million and debt with a m
ID: 2783199 • Letter: A
Question
Acetate, Inc., has equity with a market value of $23.1 million and debt with a market value of $9.24 million. Treasury bills that mature in one year yield 6 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company’s equity is 1.16. The company pays no taxes.
What is the company’s weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
What is the cost of capital for an otherwise identical all-equity company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Acetate, Inc., has equity with a market value of $23.1 million and debt with a market value of $9.24 million. Treasury bills that mature in one year yield 6 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company’s equity is 1.16. The company pays no taxes.
Explanation / Answer
Debt to equity ratio = total debt/Total equity
= 9240000/23100000
= 0.4 or 40%
WACC = % of debt in capital * Cost of debt + % of equity in capital * cost of equity
To calculate wacc we need to calculate cost of equity first
Cost of equity = risk free rate + beta ( market rate – risk free rate)
= 0.06 + 1.16 ( .11 – 0.06)
= 0.06 + 1.16 * 0.05
= 0.06 + 0058
= 0.118 or 11.8%
% of debt in capital = 9240000/(9240000+23100000)
= 9240000/32340000
= 0.2857 or 28.57%
% of equity in capital = 23100000/32340000
= 0.7143 or 71.43%
Let’s put all the values in the formula to calculate WACC
WACC = .2857 * 0.06 + 0.7143 * .118
= 0.01714 + 0.08428
= .1014 or 10.14%
The WACC of a company having all equity capital will be 11.8% ( Calculated above)
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