1. D/E is 4.0, cost of equity is 15%, pretax cost of debt is 5%, corporate tax r

Question

1. D/E is 4.0, cost of equity is 15%, pretax cost of debt is 5%, corporate tax rate is 35%, Risk free rate is 300 basis points lower than the pretax cost of debt. Find WACC.

2. Risk free rate is 2.5%. Equity risk premium (ERP) is 7%. If Beta is 1.65, what is the cost of equity capital using Capital Asset Pricing Model?

3. WACC is 16%, CF1 = 1,000,000 CF2 = 1,200,000 CF3 = 4% more than CF2 long-term growth is 4% FIND the Present Value.

4. D/E is 4.0, pretax cost of debt is 5%, corporate tax rate is 35%, Risk free rate is 300 basis points lower than the pretax cost of debt. Find the cost of equity given M&M Proposition II (from chapter 16). Presume that the unlevered company (i.e., no debt) has Net Income of $2.5 million on Total Assets of $17.86 million. See pages 528-536. FIND the cost of equity under M&M II.

Explanation / Answer

1 Debt Equity Total 4 1 5 Ratio                       0.80           0.20 1 K 5% 15% Kd after Tax=5%*(1-t) K after tax 3.25% 15% WACC=Kd*Wd+Ke*We =.0325*.8+.15*.2 WACC 5.60% 2 CAPM Ke=rf+beta*(erp) =2.5%+1.65*(7%) Ke 14.05% 3 WACC 16% Value of the Firm=1000000/(1+.16)+1200000/(1+.16)^2+(1200000*(1.04)^2/(.16-.04))/(1+.16)^3            86,83,218 4 Debt Equity Total 4 1 5 Ratio                       0.80           0.20 1 K 5% 15% Rf (5%-3%) 2% Net Income            25,00,000 Total Assets         1,78,60,000 r0 14.00% D/E 4 rd 5% tax rate 35% re=We*r0+Wd*(r0-rd)*(1-t) re=.2*14%+.8*(14%-5%)*(1-.35) 7.48%

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