Question

Calculating the Cost of Equity. Suppose stock in Lululemon Corporation has a beta of 0.80. The market risk premium is 10 percent and the risk-free rate is 2 percent. What is Lululemon's cost of equity capital?

Calculating the WACC. In addition to the information in the previous problem, suppose Boone has a target debt-equity ratio of 50 percent. Its cost of debt is 8 percent, before taxes. If the tax rate is 34 percent, what is the WACC?

Answer 1

Cost of equity capital can be found by the Capital asset pricing model:

Cost of capital

= Risk free rate + beta * market premium

= 2% + 0.8 * 10%

= 10%

Weighted Average Cost of Capital:

= (weight of debt * after tax cost of debt) + (weight of stock * cost of stock)

= (50% * 8% * ( 1 - 34%)) + (50% * 10%)

= 10.28%