Exercise 6

1. Caddie Manufacturing has a target debt–equity ratio of 0.45. Its cost of equity is 10.3
percent, and its pretax cost of debt is 6.4 percent. If the tax rate is 21 percent, what is the
company’s WACC?

2. Given the following information for Lightning Power Co., find the WACC. Assume the
company’s tax rate is 21 percent. Ignore the adjustment for default risk.
Debt: 16,500 bonds outstanding with a coupon rate of 6.2%, $1,000 par value, 25 years to
maturity, selling for 108 percent of par; the bonds make semiannual payments.
Common stock: 535,000 shares outstanding, selling for $81 per share; beta is 1.20.
Market: 7 percent market risk premium and 3.1 percent risk-free rate.

3. Amarindo, Inc. (AMR), is a newly public firm. You are estimating WACC of AMR.
Because the firm has only been listed on the stock exchange for a short time, you do not
have an accurate assessment of AMR’s equity beta. However, you do have beta data for
UAL, another comparable firm in the same industry:

Equity Beta Debt Beta Debt-Equity Ratio

UAL 1.8 0.36 1.2

AMR has a much lower debt-equity ratio of 0.35, which is expected to remain stable, and
its debt is risk free. AMR’s corporate tax rate is 25%, the risk-free rate is 5.5%, and the
expected return on the market portfolio is 11.3%.
a. Estimate AMR’s equity cost of capital.
b. Estimate AMR’s WACC.
(Hint: If debt beta β D is known, we can also apply CAPM to estimate the cost of debt as
R D=R f + β D [R m−R f ].)