The market value of XYZ Corporation's common stock is $40 million and the market value of its 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)14.0%
C)8.1%
D)10.8%

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*(expected market return - risk-free rate)
= 0.06 + 0.8*(0.1) 
= 0.14 or 14%

Next, we need to calculate the weight of equity and debt in the company's capital structure:
weight of equity = market value of equity / (market value of equity + market value of debt)
= 40 / (40 + 60)
= 0.4 or 40%
weight of debt = 1 - weight of equity
= 1 - 0.4
= 0.6 or 60%

Finally, we can calculate the firm's weighted average cost of capital (WACC):
WACC = (cost of equity * weight of equity) + (cost of debt * weight of debt)
= (0.14 * 0.4) + (0.06 * 0.6)
= 0.056 + 0.036
= 0.092 or 9.2%

Therefore, the correct answer is A) 9.2%.

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