Spencers Magic Shows Incorporated is financed 100% with equity and intends to remain this way. Spencers' common stock beta is 0.85, the expected market return average market return)is 14%, and the risk-free rate is 6%. If all of Spencers' equity is internal, what are the cost of equity and the weighted average cost of capital for Spencers?

Question

Quizplus · Accepted Answer

First, we can calculate the cost of equity using the CAPM formula:
Cost of Equity = Risk-Free Rate + Beta*(Expected Market Return - Risk-Free Rate)
Cost of Equity = 6% + 0.85*(14% - 6%)
Cost of Equity = 12.80%

Since Spencers is financed 100% by equity, the weighted average cost of capital (WACC) equals the cost of equity:
WACC = Cost of Equity = 12.80%

Spencers Magic Shows Incorporated Is Financed 100% with Equity and Intends