Weighted Average Cost of Capital test

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Feb 20, 2024

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Weighted Average Cost of Capital (Market Based) test If a firm’s pretax cost of debt is 10 percent and its state and federal tax rates are 34 percent, its after-tax cost of debt is 6.6percent. (Determine to at least one decimal place.) To calculate the after-tax cost of debt, you can use the formula: After-tax cost of debt=Pretax cost of debt×(1−Tax rate)After-tax cost of deb t=Pretax cost of debt×(1−Tax rate) In this case, the pretax cost of debt is 10 percent, and the tax rate is 34 percent. After-tax cost of debt=0.10×(1−0.34)After-tax cost of debt=0.10×(1−0.34) After-tax cost of debt=0.10×0.66After-tax cost of debt=0.10×0.66 After-tax cost of debt=0.066After-tax cost of debt=0.066 If a firm has a Beta ( β ) of 0.8, a risk-free rate of return ( k RF ) of 3%, and a market risk premium (MRP) of 12%, then the capital asset pricing model (CAPM) suggests that the firm’s cost of equity is approximately 12.6%. (Use the following formula to calculate your answer to one decimal point. Ret = R f + R m x B The Capital Asset Pricing Model (CAPM) formula is given by: Ret=Rf+(Rm× � )Ret=Rf+(Rm× β ) where:

 RetRet is the expected return on the equity.  RfRf is the risk-free rate of return.  RmRm is the market risk premium.  � β is the Beta coefficient. In this case, the values are:  RfRf = 3%  RmRm = 12%  � β = 0.8 Plug in these values into the formula: Ret=3%+(12%×0.8)Ret=3%+(12%×0.8) Ret=3%+9.6%Ret=3%+9.6% Ret=12.6%Ret=12.6% If a firm’s market value was $6.8 billion and the value of its debt was $1.8 billion, the percent of the firm’s equity would be approximately 73.53 percent. 6.8-1.8 = 5 5/6.8 = 0.73529 X100 73.53% If a firm has a debt-to-asset ratio of 40 percent, 60 percent of its assets must be financed with equity.

Assume that a firm has a debt-to-equity of 70 percent, and 30 percent of its assets are financed with equity. If the firm’s after-tax cost of debt is 6 percent and its cost of equity is 20 percent, then its weighted average cost of capital (WACC) is 10.2 percent. (Determine to at least one decimal place). The weighted average cost of capital (WACC) is calculated using the formula: WACC=(EV×Cost of Equity)+(DV×After-tax Cost of Debt )WACC= ( VE ×Cost of Equity ) + ( VD ×After-tax Cost of Debt ) where:  EE is the market value of equity,  DD is the market value of debt,  VV is the total market value of equity and debt ( E+DE+D ),  Cost of Equity is the required rate of return on equity,  After-tax Cost of Debt is the cost of debt adjusted for taxes. Given the debt-to-equity ratio of 70%, we can express the market value of debt ( DD ) and equity ( EE ) in terms of the total value ( VV ): D=0.7×VD=0.7×V E=0.3×VE=0.3×V Now, plug in the values into the WACC formula: WACC=(0.3×VV×0.20)+(0.7×VV×0.06)WACC= ( V0.3×V ×0.20 ) + ( V0.7×V ×0.06 ) WACC=0.3×0.20+0.7×0.06WACC=0.3×0.20+0.7×0.06 WACC=0.06+0.042WACC=0.06+0.042 WACC=0.102WACC=0.102

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Converting this to a percentage, the weighted average cost of capital (WACC) is approximately 10.2%10.2% (rounded to one decimal place). If a firm’s current stock price ( P0 ) is $60, its expected dividend is $3, and its growth rate ( g ) is 5 percent, then by using the discounted cash flows model (DCF), the firm’s estimated cost of equity is 10 percent. Use the following formula to calculate your answer: Price = Div / ror – g The formula you provided seems to be rearranged incorrectly. The correct formula for the Gordon Growth Model (Dividend Discount Model or DDM) is: Price=DivCost of Equity−Growth RatePrice= Cost of Equity−Growth RateDiv To find the estimated cost of equity ( � r ), we can rearrange the formula: Cost of Equity=DivPrice+Growth RateCost of Equity= PriceDiv +Growth Rate Now, plug in the given values: Cost of Equity=$3$60+0.05Cost of Equity= $60$3 +0.05 Cost of Equity=0.05+0.05Cost of Equity=0.05+0.05 Cost of Equity=0.10Cost of Equity=0.10 Converting this to a percentage, the estimated cost of equity is 10%10% .

If a firm has a Beta ( β ) of 2, a risk-free rate of return ( k RF ) of 4%, and a market risk premium (MRP) of 15%, then the capital asset pricing model (CAPM) suggests that the firm’s cost of equity is approximately 34%. Use the following formula to calculate your answer: Ret = R f + R m x B The Capital Asset Pricing Model (CAPM) formula is given by: Ret=Rf+(Rm× � )Ret=Rf+(Rm× β ) where:  RetRet is the expected return on the equity.  RfRf is the risk-free rate of return.  RmRm is the market risk premium.  � β is the Beta coefficient. In this case, the values are:  RfRf = 4%  RmRm = 15%  � β = 2 Plug in these values into the formula: Ret=4%+(15%×2)Ret=4%+(15%×2) Ret=4%+30%Ret=4%+30% Ret=34%Ret=34% Therefore, the firm's cost of equity, according to the Capital Asset Pricing Model (CAPM), is approximately 34%34% .

If a firm has a Beta ( β ) of 1.5, the risk-free rate of return ( k RF ) is 2 percent, and the market risk premium (MRP) is 10 percent, the capital asset pricing model (CAPM) suggests that the firm’s cost of equity is approximately 17 percent. Use the following formula to calculate your answer: Ret = R f + R m x B The Capital Asset Pricing Model (CAPM) formula is given by: Ret=Rf+(Rm× � )Ret=Rf+(Rm× β ) where:  RetRet is the expected return on the equity.  RfRf is the risk-free rate of return.  RmRm is the market risk premium.  � β is the Beta coefficient. In this case, the values are:  RfRf = 2%  RmRm = 10%  � β = 1.5 Plug in these values into the formula: Ret=2%+(10%×1.5)Ret=2%+(10%×1.5) Ret=2%+15%Ret=2%+15% Ret=17%Ret=17% Therefore, the firm's cost of equity, according to the Capital Asset Pricing Model (CAPM), is approximately 17%17% .

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In the discounted cash flow model, the firm’s expected annual dividend ( D1 ) is divided by the firm’s current stock price ( P0 ), and the result is added to the firm’s expected growth rate ( g ).