LipTea Incorporated purchases raw materials and has processing plants around the world. The firm finances 30% of its assets with debt and 70% with equity, has a 30% average tax rate, and can issue bonds at a pre-tax rate of 7%. Their standard deviation of returns is roughly 1.50 times as great as the market's returns, and has a correlation with the market of 0.45. If the risk-free rate of return is 5% and the expected return on the international market portfolio is 14%, what is the firm's WACC?
A) 7.75%
B) 8.38%
C) 12.24%
D) There is not enough information to answer this question.

Question

Quizplus · Accepted Answer

1. Calculate the cost of equity:
    Re = Rf + Beta*(Rm-Rf)
       = 5% + 1.50*(14% - 5%)
       = 18.5%

2. Calculate the cost of debt:
    Rd = 7%

3. Calculate the tax rate:
    T = 30%

4. Calculate the weight of equity and debt:
    We = 0.70
    Wd = 0.30

5. Calculate the WACC:
    WACC = (We * Re) + (Wd * Rd) * (1 - T)
         = (0.70 * 18.5%) + (0.30 * 7%) * (1 - 0.30)
         = 8.38% 
         Therefore, the answer is option B

LipTea Incorporated Purchases Raw Materials and Has Processing Plants Around