Question

Ganado and Equity Risk Premiums. Maria​ Gonzalez, Ganado's Chief Financial​ Officer, estimates the​ risk-free rate to be 3.50 %​, the​ company's credit risk premium is 3.60​%, the domestic beta is estimated at 1.12​, the international beta is estimated at 0.86​, and the​ company's capital structure is now 80​% debt. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is 7.60​% and the​ company's effective tax rate is 39​%. Calculate both the CAPM and ICAPM weighted average costs of capital for the following equity risk premium estimates. a. 8.10​% b. 7.10​% c. 4.90​% d. 3.90​%

Answer 1

Answer:

WACC (CAPM) 5.2%

WACC (ICAPM) 5.03%

Explanation:

The weighted average cost of capital is

Ke * E/ E+D + Kd * (1 -t) D / E+D

Ke = Rf + (Rm - Rf) * $\beta$

Ke (CAPM) = 3.50% + (8% - 3.50%) * 1.12

Ke (CAPM) = 7.532%

Kd (CAPM) = Kd (1-t)

Kd (CAPM) = 7.60 (1-39%)

Kd (CAPM) = 4.636%

WACC (ICAPM) : 7.532 * 20% + 4.636 * 80%

WACC (CAPM) = 5.2164%

Ke (ICAPM) = 3.50% + (8% - 3.50%) * 0.86

Ke (ICAPM) = 6.596%

Kd (ICAPM) = Kd (1-t)

Kd (ICAPM) = 7.60 (1-39%)

Kd (ICAPM) = 4.636%

WACC (ICAPM) : 6.596 * 20% + 4.636 * 80%

WACC (CAPM) = 5.03%