Question

Rogue Ales has 1 million shares outstanding, trading at $25 per share. Based on the CAPM, the expected return on equity is 14%. Moreover, the firm has issued 1,000 bonds with a face value of $10,000 per bond. The bonds currently trade at 80% of their face value. Investors, the expected return on debt is 7%. Assume that Rogue Ales does not pay taxes (i.e., tax rate).

A) 14%
B) 11.2%
C) 7%
D) 8%

Answer 1

The weighted average cost of capital (WACC) for Rogue Ales, which includes market values of equity and debt and their respective expected returns, without considering taxes, is 11.2%. Hence, option (B) is correct.

Step-by-step explanation:

The question seems to be asking for the weighted average cost of capital (WACC) for Rogue Ales.

To calculate the WACC, we need to combine the expected return on equity and the expected return on debt, with each being weighted by their respective proportion in the company's capital structure.

The market value of equity is 1 million shares multiplied by $25 per share, which equals $25 million. The total market value of debt is 1,000 bonds multiplied by $10,000 per bond, times 80% (since they trade at 80% of face value), which equals $8 million.

Since Rogue Ales has no taxes, the WACC formula will simply be the proportion of equity times the return on equity, plus the proportion of debt times the return on debt.

The calculation would then be: ($25M/$33M) * 14% + ($8M/$33M) * 7% = 11.2%.

Hence, the answer is B) 11.2%.