Consider a firm with a market value of total assets of $100 million. The firm has $40 million of debt and $60 million of equity. The firm's cost of debt equals 8%, its cost of equity is 15%. We assume that B=0.20 and B= 1.20. A main competitor has $10 million less debt and a debt ratio of 0.25. The cost of debt for this firm equals 7.3%. The corporate tax rate for both firms equals 40%. Answer the following questions. 1) Calculate the risk free interest rate and the market risk premium. 2) Calculate the firm's asset beta and its cost of capital. 3) Determine the competitor's equity and debt beta. 4) What would be the appropriate cost of capital to use for an expansion investment by the competitor?
Consider a firm with a market value of total assets of $100 million. The firm has $40 million of debt and $60 million of equity. The firm's cost of debt equals 8%, its cost of equity is 15%. We assume that B=0.20 and B= 1.20. A main competitor has $10 million less debt and a debt ratio of 0.25. The cost of debt for this firm equals 7.3%. The corporate tax rate for both firms equals 40%. Answer the following questions. 1) Calculate the risk free interest rate and the market risk premium. 2) Calculate the firm's asset beta and its cost of capital. 3) Determine the competitor's equity and debt beta. 4) What would be the appropriate cost of capital to use for an expansion investment by the competitor?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Can you help solve especially the first question. I know we have to make use the two function with two unknowns. But is there another way to do this if not how can solve this
Transcribed Image Text:Practice problem on asset betas and cost of capital
Consider a firm with a market value of total assets of $100 million. The firm has $40 million of debt and $60 million
of equity. The firm's cost of debt equals 8%, its cost of equity is 15%. We assume that B, = 0.20 and B-= 1.20. A
main competitor has $10 million less debt and a debt ratio of 0.25. The cost of debt for this firm equals 7.3%. The
corporate tax rate for both firms equals 40%. Answer the following questions.
1) Calculate the risk free interest rate and the market risk premium.
2) Calculate the firm's asset beta and its cost of capital.
3) Determine the competitor's equity and debt beta.
4) What would be the appropriate cost of capital to use for an expansion investment by the competitor?
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