Solving: Weighted Average Cost of Capital
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Scenario: McCoy, Inc., has equity with a market value of $40 million and debt with a market value of $20 million. The cost of the debt is 6% semi-annually. Treasury bills that mature in one year field 5% per annum, and the expected return on the market portfolio over the next is 15%. The beta of McCoy's equity is 0.8. The firm pays no taxes.
Questions:
1. What is McCoy's debt-equity ratio?
2. What is the firm's weighted average cost of capital?
3. What is the cost of capital for an otherwise identical all-equity firm?
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Solution Summary
This solution is comprised of a detailed, step by step response which explains the computation of the weighted average cost of capital under different circumstances. All required formulas and variables have been included, along with all of the calculations.
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1. mCCOY
debt-equity ratio?
Debt/Equity=20/40
=0.5
2. What is the firm's overall required return? It is the weighted average cost of capital - that is the weighted average of cost of equity and cost of debt.
1. Cost of equity
Ke = Rf+b(Km-Rf)=13.00%
Ke= Cost of Equity ...
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