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Cost of Capital

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Acetate, Inc., has equity with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14 percent per annum. Treasury bills that mature in one year yield 8 percent per annum, and the expected return on the market portfolio over the next year is 18 percent. The beta of Acetate's equity is 0.9. The firm pays no taxes.

What is Acetate's debt-equity ratio?
What is the firm's weighted average cost of capital?
What is the cost of capital for an otherwise identical all-equity firm?

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Solution Summary

The solution explains the calculation of debt to equity ratio and the weighted average cost of capital. It also explains the calculation of the cost of capital for an otherwise identical all-equity firm.

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1. MV of Debt=10, MV of Equity=20, so D/E = 50%.

2. Because you are given an equity beta (i.e., unlevered) you have to lever it to get the proper data to compute the WACC. To lever up the beta, use the following formula: BL = BU * (1+(1-t)(d/e)). Since the ...

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