Question

Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.15, and its cost of equity is 11.55%. Because the firm has no debt in its capital structure, its weighted average obst of capital (WACC) also equals 11.55%. The risk-free rate of interest (TRF) is 3.5%, and the market risk premium (RPM) is 7%. Blue Rar's marginal tax rate is 25% Blue Ram is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table. D/Cap Ratio Levered Beta E/Cap Ratio 1.0 Bond Rating Before-Tax Cost of Debt (ra) WACC D/E Ratio 0.00 0.0 1.15 Cost of Equity (r.) 11.55% 13.062% 15.575% 11.55% 0.25 7.294 11.530% 0.67 BBB 7.7 1.725 BB 8.9% 2.444 12.248% 0.8 0.2 11.01 4.600 35.7009

Answer 1

I have solved the problem using CAPM approach.
Finding out the missing figures & Finding levered Beta when the debt is 20% or (0.2) 4 equity is 0.8, DIE ratio - 0.25 kd (pretax)=7,2%. K = 3.062% & WAC = 11.530%, using CAPM approach. Ke = Rp + B (Rm -Rf) Given Rf - 3.5%, 13.062 = 3.5+ B (1) Rpm - 1% B = 13.062-3.5 = 9.562 = 1.366 i levered Beta = 1.366 ③ For third case component ratio a Debt 0.4 I need to find wACC individual cost WACC Kd = Int (100%-tax) = 5.775 X014 = 2.31 = 7.7 (100% 25%) = 5.775 Ke=15157 - 15.575 80 16 = 9.345 WACC or Ko= 110655 6 Equity Total 0.6 7.0 016. in the cost of ke (equity) when debt level is total capital structure using CAPM approach. Re = Rft B (Rm-Rf) Given = 3.5+2.444 (7) Ke = 201608 B = 2,444 Rf = 3.5/ Rpm = 7%

4) When the debt level is 0.8 calculation of DIE ratio D/E ratio = Debt to capital ratio Equity to capital ratio = 018/012 = 4 Calauction of WACC a) component ratio Incliviclual cost WACC a) Dent 0.8 Kd = int(100 - tax rate) = 0.8X8.925 = 1119 (100%-25%) = 7.14 = 8:925 b) Equity 0.2 Ke= 35.100% = 0.2X 35.700 =010 = 1.14 Total 1.0 WACC or ko = 14.28 2 D/cap ratio filled Elcup ratio in table DIE Before tx rutio Cost of debt levered beta 1 2 3 14 5 0.0 0.2 0.4 0.6 0.8 1.0 0.8 0.6 0.4 0.2 0.60 0.25 0.67 1.50 4 - 7.2% 7.7% 8.el 11.9% 1.15 1.366 1.725 2.444 4.600 cost of equity WACC while 11.557. 11.55% 13.062% 11.530% 15.575% 11.655%. 20.608% 12.248% 35.700% 14.28% in the above # answers filled are underlined in table.