The market value of XYZ Corporation's common stock is 40 million and the market value of the risk-free debt is 60 million. The beta of the company's common stock is 0.8, and the expected market risk premium is 10%. If the Treasury bill rate is 6%, what is the firm's cost of capital? (Assume no taxes.)
A) 9.2%
B) 14%
C) 8.1%
D) None of the above

Question

Quizplus · Accepted Answer

The firm's cost of capital is calculated using the weighted average cost of capital (WACC) formula. The cost of equity is calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium = 6% + 0.8 * 10% = 14%. The firm's cost of capital is the weighted average of the cost of equity and the cost of debt (risk-free rate), weighted by their respective market values: WACC = (40/100)*14% + (60/100)*6% = 9.2%.

The Market Value of XYZ Corporation's Common Stock Is 40