Question

Galt Industries has no debt, total equity capitalization of $700 million, and an equity beta of 1.4. Included in Galt's assets is $70 million in cash and risk-free securities. Assume the risk-free rate is 4% and the market risk premium is 6%. Galt's WACC is closest to:

Answer 1

Galt Industries' WACC is calculated using the CAPM formula since it's only financed by equity, resulting in a WACC of 12.4%.

Step-by-step explanation:

The question seeks to calculate the Weighted Average Cost of Capital (WACC) for Galt Industries, which has no debt and an equity beta of 1.4. Since the company is entirely financed by equity, the WACC is equal to the cost of equity. The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM), which is defined as: Cost of Equity = Risk-free rate + Beta * Market risk premium. Plugging in the values provided: Risk-free rate = 4%, Beta = 1.4, Market risk premium = 6%, the calculation becomes Cost of Equity = 4% + 1.4 * 6%. Therefore, the WACC for Galt Industries, in this case, is identical to the cost of equity.

After performing the calculation: Cost of Equity = 4% + 1.4 * 6% = 4% + 8.4% = 12.4%. Therefore, the WACC is 12.4%.