Acetate, Inc., has equity with a market value of $24 million and debt with a mar
ID: 2789999 • Letter: A
Question
Acetate, Inc., has equity with a market value of $24 million and debt with a market value of $9.6 million. The cost of debt is 10 percent per year. Treasury bills that mature in one year yield 6 percent per year, and the expected return on the market portfolio is 11 percent. The beta of Acetate’s equity is 1.25. The firm pays no taxes.
a. What is Acetate’s debt-equity ratio? (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)
Debt–equity ratio
b. What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)
Weighted average cost of capital %
c. What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)
Cost of capital %
Explanation / Answer
Answer 1 Debt/Equity ratio= Market value of debt/Market value of equity Debt/Equity ratio= 9.6/24 Debt/Equity ratio= 0.40 Answer 2 Weight of debt=debt/debt+equity weight of debt= 9.6/9.6+24 weight of debt= 28.57% Weight of equity= Equity/debt+Equity Weight of equity= 24/(9.6+24) Weight of equity= 71.43% cost of debt= 10% Cost of Equity(using CAPM)= Ke=Risk free rate +beta *(market return-risk free rate) Ke=6 + 1.25*(11-6) Ke= 12.25% WACC= weight of debt*cost of debt+ weight of equity*cost of equity WACC= .2857*10+.7143*12.25 WACC= 11.61 WACC= 11.61% Answer 3 if all equity Compute beta of asset(unlevered beta) Beta(asset)= beta/(1+(1-tax)*D/E) Beta(asset)= 1.25/1.4 Beta(asset)= 0.89 Beta(levered)= Beta*(1+(1-t)*D/E) Beta(levered)= 0.89*(1+0) Beta(levered)= 0.893 Ke=Risk free rate +beta *(market return-risk free rate) Ke= 6+0.893*(11-6) Ke= 10.46% WACC=Cost of equity*weight of equity WACC= 10.46*1 WACC= 10.46%