LipTea Incorporated purchases raw materials and has processing plants around the world.
The firm has an average pretax cost of debt of 8%, an average tax rate of 40%, and an international equity beta of 1.2. If the risk-free rate of return is anticipated to be 4% and the return to the international market portfolio to be 12%, what is LipTea's after-tax cost of equity?

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the Capital Asset Pricing Model (CAPM):
Cost of Equity = Risk-Free Rate + Beta*(Market Risk Premium)
Cost of Equity = 4%+ 1.2*(12% - 4%) = 13.6%

Next, we need to calculate LipTea's after-tax cost of debt:
After-Tax Cost of Debt = Pretax Cost of Debt * (1 - Tax Rate)
After-Tax Cost of Debt = 8% * (1 - 0.4) = 4.8%

Finally, we can use the following formula to calculate the weighted average cost of capital (WACC):
WACC = (Cost of Equity * Equity Weight) + (After-Tax Cost of Debt * Debt Weight)

Assuming that LipTea has a debt-to-equity ratio of 0.5, the weights would be 0.5 for debt and 0.5 for equity:
WACC = (0.136 * 0.5) + (0.048 * 0.5) = 9.2%

Therefore, LipTea's after-tax cost of equity is 13.6%.

LipTea Incorporated Purchases Raw Materials and Has Processing Plants Around