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Finding cost of equity, debt and WACC

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1) Company X is an all-equity firm (i.e. it has no debt financing) with a beta of 1.15. If the risk-free rate is 5% and the market risk premium is 9% (the expected return in the market is 14%), determine the cost of equity capital for Company X.

2) Nexel Online has a beta of 1.4 and has a debt-to-equity ratio of 0.75. (NOTE: D/E Ratio is not the same as weight of debt. From the D/E Ratio you need to calculate D/[D+E] and E/[D+E] to solve the problem correctly.) The expected return on the market is 13.0% and the risk-free rate is 6.0%. Apex can borrow additional funds at the current market interest rate of 9%. The corporate tax rate for Apex is 36%.

A. Calculate Nexel's cost of equity

B. Calculate Nexel's after-tax cost of debt

C. Calculate Nexel's weighted average cost of capital

3) Calculate the weighted average cost of capital for Premium Products given the following information:

Market Value of Debt $600,000
Market Value of Stock $900,000
Cost of Debt 9.5%
Risk-free Rate 5.0%
Expected Market Return 14.2%
Beta for Allied Power 1.2
Corporate Income Tax Rate 34.0%

4) Calculate the weighted average cost of capital for Kirkland Products given the following information:
Number of Shares Outstanding 1,000,000
Market Price per share $30.00
Market Value of Debt $20,000,000
Cost of Equity 18.0%
Cost of Debt 9.5%
Corporate Income Tax Rate 34.0%

5) Kirkland (the company from the previous problem) is considering a project that costs $750,000 & will generate after-tax cash flows of $320,000 at the end of year 1, $315,000 at the end of year 2, and $310,000 at the end of year 3. If the project is deemed to have the same risk as the overall firm, should Kirkland take the project and why or why not?

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Solution Summary

There are five problems. Solutions to these problems explain the formula and steps to find out cost of equity, cost of debt and weighted average cost of capital.

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1)

Risk free return=rf=5%
Market return=rm=14%
Beta=b=1.15
Cost of equity=rf+b(rm-rf)=5%+1.15*(14%-5%)=15.35%

2)
A.Calculate Nexel's cost of equity

Risk free return=rf=6%
Market return=rm=13%
Beta=b=1.4
Cost of equity=rf+b*(rm-rf)=6%+1.4*(13%-6%)=15.80%

B. Calculate Nexel's after-tax cost of debt
After tax cost of debt=Cost of debt*(1-tax rate)=9%*(1-36%)=5.76%

C. Calculate Nexel's weighted average cost of capital

D/E ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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