A firm has 5,000,000 shares of common stock outstanding, each with a market price of $8.00 per share. It has 25,000 bonds outstanding, each selling for $1100 with a $1000 face value. The bonds mature in 12 years, have a coupon rate of 9%, and pay coupons semi-annually. The firm's equity has a beta of 1.4, and the expected market return is 15%. The tax rate is 35% and the WACC is 14%. Calculate the risk-free rate.
A) 2.05%
B) 15.27%
C) 20.18%
D) 1.19%

Question

Quizplus · Accepted Answer

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

r = Rf + β(Rm - Rf)

Where,

r = Required Rate of Return (WACC) = 14%
β = Beta = 1.4
Rm = Expected Market Return = 15%

We need to solve for Rf.

Rearranging the formula:

Rf = (r - β(Rm - r))

Rf = (0.14 - 1.4(0.15 - 0.14))
Rf = 0.0205 or 2.05%

Therefore, the answer is A) 2.05%.

A Firm Has 5,000,000 Shares of Common Stock Outstanding, Each