Question

Using the same information from before, please calculate the WACC of Correct Inc. assuming a risk free rate of 2.5%, a company Beta of 1.2 and a market risk premium of 6%.

Answer 1

WACC = 21.7%

Step-by-step explanation:

The firm is an all-equity finance firm which implies that the company uses only equity funds to finance its its operation without the use of debt. Therefore, the cost of the equity of the firm would be the same as its cost of capital (WACC)

The WACC can be determined using the the capital asset pricing model (CAPM). The CAPM relates the price of a share to the market risk or systematic risk. The systematic risk is that which affects all the all the economic agents, e.g inflation, interest rate e.t.c

Using the CAPM , the required rate of return is given as follows:

E(r)= Rf +β(Rm-Rf)

E(r) - required return

β- Beta

Rm- Return on market

Rf- Risk-free rate

Rm-Rf- Market risk premium

DATA

E(r) =? , Rf- 2.5%, Rm-Rf- 6% , β- 1.2

E(r) = 2.5% + 1.2× (16%) = 21.7 %

Cost of equity = 21.7%

WACC = 21.7%