Question

Ganado and Equity Risk Premiums.  Maria​ Gonzalez, Ganado's Chief Financial​ Officer, estimates the​ risk-free rate to be 3.90 % ​, the​ company's credit risk premium is 4.10 ​%, the domestic beta is estimated at 0.94 ​, the international beta is estimated at 0.61 ​, and the​ company's capital structure is now 70 ​% debt. The​ before-tax cost of debt estimated by observing the current yield on​ Ganado's outstanding bonds combined with bank debt is 8.20 ​% 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. 8.80%

b.7.80%

c.6.00%

d.5.10%

a. Using the domestic​ CAPM, what is​ Ganado's weighted average cost of capital if the​ firm's equity risk premium is 8.80 %​?

Answer 1

a)

		Domestic CAPM
Cost of equity	Risk free rate +[Beta(market risk premium]	3.9+[.94*8.8] 3.9+ 8.272 12.172%
After tax cost of debt	Before tax cost [1-Tax rate]	8.20 [1-.39] 8.20*.61 5.002%
WACC	[After tax cost of debt*weight of debt]+[Cost of equity *weight of equity]	[5.002*.70]+[12.172*.30] 3.5014+ 3.6516 7.153%

If weight of debt is 70% then 100-70 = 30% is equity