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 percent, and pay coupons semiannually. The firm's equity has a beta of 1.5, and the expected market return is 20 percent. The tax rate is 35 percent and the WACC is 16 percent. What is the risk-free rate?
A)4.8 percent
B)11.4 percent
C)27.6 percent
D)30.0 percent

Question

Quizplus · Accepted Answer

To calculate the risk-free rate, we can use the CAPM formula:
r = Rf + β*(Rm - Rf)
where,
r = required return (WACC)
β = beta of the equity
Rm = expected market return
Solving for Rf, we get:
Rf = (r - β*Rm)/(1 - β)
Substituting the given values, we get:
16% = (Rf + 1.5*(20% - Rf))/(1 - 1.5)
Solving for Rf, we get:
Rf = 4.8%
Therefore, the answer is choice A) 4.8 percent.

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