A firm has 5,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 55,000 bonds outstanding, each selling for $990 with a $1,000 face value. The bonds mature in 15 years, have a coupon rate of 8 percent, and pay coupons semiannually. The firm's equity has a beta of 2.0, and the expected market return is 15 percent. The tax rate is 21 percent and the WACC is 16 percent. Calculate the risk-free rate.
A) 27.68 percent
B) 1.79 percent
C) 3.56 percent
D) 2.12 percent

Question

Quizplus · Accepted Answer

The risk-free rate can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Rearranging gives Risk-Free Rate = (Expected Return - Beta * Market Return) / (1 - Beta). Substituting the given values: 16% = Risk-Free Rate + 2.0 * (15% - Risk-Free Rate), solving gives Risk-Free Rate = 3.56%.

A Firm Has 5,000,000 Shares of Common Stock Outstanding, Each