A firm has 5,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 55,000 bonds outstanding, each selling for $990 with a $1,000 face value. The bonds mature in 15 years, have a coupon rate of 8 percent, and pay coupons semiannually. The firm's equity has a beta of 2.0, and the expected market return is 15 percent. The tax rate is 35 percent and the WACC is 16 percent. Calculate the risk-free rate.
A)27.68 percent
B)1.79 percent
C)2.32 percent
D)2.12 percent

Question

Quizplus · Accepted Answer

To find the risk-free rate, use the Capital Asset Pricing Model (CAPM): Expected Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate). Rearranging gives: Risk-free Rate = (Expected Return - Beta * Market Return) / (1 - Beta). Given the WACC is 16%, and assuming it represents the expected return, solve for the risk-free rate.

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