Use the information for the question(s)below.
Omicron Industries' Market Value Balance Sheet ($ Millions)
and Cost of Capital Omicron Industries' New Project Free Cash Flows (Millions) Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
-Omicron's unlevered cost of capital is closest to:
A)8.75%.
B)7.10%.
C)9.60%.
D)7.50%.

Question

Use the information for the question(s)below.
Omicron Industries' Market Value Balance Sheet ($ Millions)
and Cost of Capital  Omicron Industries' New Project Free Cash Flows (Millions)  Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
-Omicron's unlevered cost of capital is closest to:
A)8.75%. 
B)7.10%. 
C)9.60%. 
D)7.50%.

Quizplus · Accepted Answer

To find the unlevered cost of capital, we can use the formula:
Unlevered Cost of Capital = Cost of Equity / (1 + (1 - Tax Rate) * (Debt/Equity))

First, we need to find the cost of equity. We can use the Capital Asset Pricing Model (CAPM) to do this:
Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium
= 5% + 1.2 * 6%
= 12.2%

Next, we need to find the debt to equity ratio:
Debt/Equity = Total Debt / Total Equity
= 100 / 200
= 0.5

Assuming a tax rate of 40%:
Unlevered Cost of Capital = 12.2% / (1 + (1 - 0.4) * 0.5)
= 9.60%

Therefore, the closest choice is C) 9.60%.

Use the Information for the Question(s)below