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Medical Associates is a large for-profit group practice. The firm’s beta coefficient is 1.6; the rate...

Medical Associates is a large for-profit group practice. The firm’s beta coefficient is 1.6; the rate of return on 20 year Treasury bonds is 9%;and the expected ROR on the Market is 13%. The firm’s target capital structure calls for 50% debt financing, the interest rate required on new debt is 10% and its tax rate is 40%.

a. What is the firm’s estimated cost of equity according to CAPM?

b. What is the WACC (CCC)?

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Answer #1

a) Firm's estimated cost of equity according to CAPM = Risk free rate of return + beta(Return on market - Risk free rate of return)

=9%+ 1.6(13%-9%)

=9%+1.6(4%)

=9%+6.4%

=15.40%

b) Let's now calculate after tax cost of debt

After tax cost of debt = Interest rate(1-tax rate)

=10%(1-0.4)

=10%(0.6)

=6%

Statement showing WACC

Particulars Weight Cost of capital WACC
a b c =axb
Equity 50% 15.40% 7.70%
Debt 50% 6.00% 3.00%
WACC 10.70%

Thus WACC = 10.70%

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