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The total market value of the equity of Okefenokee Condos is $8 million, and the total value of its debt is $2 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 12%. The Treasury bill rate is 3%, and investors believe that Okefenokee's debt is essentially free of default risk.
a. Estimate the WACC assuming a tax rate of 21%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
b. Estimate the discount rate for an expansion of the company’s present business. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
c. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is 1.0. What is the required
Given,
equity =$ 8 million
debt =$2 million
risk free rate= treasury bill rate = 3%
beta =0.5
market risk premium =12%
a. proportion of equity =8/12=0.96
proportion of debt=2/12=0.24
since , Okefenokee's debt is risk free cost of debt=3%
tax rate=21%
so = Proportion of debt*cost debt* (1-tax rate) +proportion of equity *cost of equity=8.95%
b. usually a discount rate for a news expansion project is WAAC. So expansion of so company business would be equal to WAAC,i.e. 8.95%
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