A firm has 1,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 15,000 bonds outstanding, each selling for $900 (with a face value of $1,000). The bonds mature in 15 years, have a coupon rate of 10%, and pay coupons semi-annually. The firm's equity has a beta of 1.5, and the expected market return is 20%. The tax rate is 35% and the WACC is 16%. What is the risk-free rate?
A) 4.8%
B) 11.4%
C) 27.6%
D) 30.0%

Question

Quizplus · Accepted Answer

To calculate the risk-free rate, we can use the CAPM formula:

r = r_f + β (r_m - r_f)

Where r = WACC = 16%, β = 1.5, r_m = expected market return = 20%

Solving for r_f, we get:

r_f = (r_m - β(r_m - r)) / (1 + tax rate)
r_f = (20% - 1.5(20% - 16%)) / (1 + 35%) 
r_f = 4.8%

Therefore, the risk-free rate is 4.8%.

A Firm Has 1,000,000 Shares of Common Stock Outstanding, Each