Acetate, Inc., has equity with a market value of $23.7 million and debt with a m
ID: 2804630 • Letter: A
Question
Acetate, Inc., has equity with a market value of $23.7 million and debt with a market value of $9.48 million. 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 the company’s equity is 1.22. The company pays no taxes.
What is the company’s weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
What is the cost of capital for an otherwise identical all-equity company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Acetate, Inc., has equity with a market value of $23.7 million and debt with a market value of $9.48 million. 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 the company’s equity is 1.22. The company pays no taxes.
Explanation / Answer
Answer a.
The market vaue of equity = 23.7 million
and market value of debt = 9.48 million
Thus debt to equity ratio = debt / equity = 9.48/23.7 = 0.4
Answer b.
Cost of equity = Ke = rf+beta*(rm-rf)
=0.06+1.22*(0.11-0.06)
=0.06+0.061
=0.121
and cost of debt = Kd = 0.06
Weight of debt = Wd = 9.48 / (9.48+23.7) = 9.48 / 33.18 = 0.2857
Weight of equity = We = 1-Wd = 1-0.2857 = 0.7143
WACC = Ke*We + Kd*Wd
=0.121*0.7143 + 0.06*0.2857
=0.08643 + 0.0171
=0.10357
=10.357%
Answer C.
The cost of capital for an otherwise identical all equity company will have weight of equity as 100% and thus the cost of capital will be cost of equity = 0.121 = 12.1%