Cost of Capital Acetate, Inc., has equity with a market value of $22.3 million a
ID: 2613563 • Letter: C
Question
Cost of Capital
Acetate, Inc., has equity with a market value of $22.3 million and debt with a market value of $11.15 million. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio is 10 percent. The beta of Acetate’s equity is 1.08. The firm pays no taxes.
What is the firm’s weighted average cost of capital? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Acetate, Inc., has equity with a market value of $22.3 million and debt with a market value of $11.15 million. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio is 10 percent. The beta of Acetate’s equity is 1.08. The firm pays no taxes.
Explanation / Answer
a. Debt - Equity Ratio = Debt /Equity = 11.15/22.3 * 100 = 50%
b. Kd = 4%
Ke = 10%
Weight of debt = 11.15/33.45 = 0.33
Weight of Equity = 22.3/33/45 = 0.67
Weighted Average cost of capital = Kd*Weight of debt + Ke*Weight of Equity = 4*0.33 + 10*0.67 = 8.02%
c. Cost of Capital = Ke = 10%