Question

1. We have the following information for Anheuser-Busch Companies, Inc Company Beta Market Market Bond Value Value Rating of of Debt Equity 40605 5375 Anheuser-0.5 Busch Assuming no tax is paid. Furthermore, we have the following economy-wide information Government Bond yields 10-year 4.5% Bond yield spreads (ie. bond yield -risk free rate) for A+ rating 10-year 1.00% Assume that the expected return on the S&P 500 is 10%. Estimate Anheuser-Busch's WACC using this information. 2. Identical Twin Beer, Co. has exactly the same business risk as Anheuser-Busch, but it has 100% of equity and no debt. According to the data in question 1. what is the beta of Identical Twin? What is its cost of capital?

Answer 1

Risk free rate = Government Bond Yields =4.5%

As Bond Yields - Risk free rate =1% (for A+ bonds)

=> Bond Yields = Risk free rate+ 1% (for A+ bonds)

=> Bond Yield = 5.5% which is also the cost of Debt of Anheuser-Busch Companies

From Capital Asset Pricing model

Cost of equity = Risk free rate + Beta * (Market rate of return - Risk free rate)

Market rate of return can be taken as S&P rate of return =10%

So,Cost of equity= 4.5%+ 0.5* (10%-4.5%)

= 7.25%

As there is no tax

So, WACC = Weight of Debt * Cost of Debt + Weight of Equity * cost of equity

=5375/(5375+40605)*5.5% + 40605/(5375+40605)*7.25%

=7.0454274% or 7.05%

2. As Identical twin Beer Co has no debt, its beta will be the same as Anheuser - Busch but without debt

As Beta of Anheuser-Busch is leverd beta (with debt) , the Unlevered beta (without debt) will be the beta of Identical twin beer Co

Unlevered Beta = Levered beta/ (1+ (1-tax rate) *Debt/Equity)

As tax rate =0

Unlevered Beta = 0.5/ (1+5375/40605) = 0.44 which is the Beta of Identical Twin Beer Co

From Capital Asset Pricing model

Cost of equity = Risk free rate + Beta * (Market rate of return - Risk free rate)

Market rate of return can be taken as S&P rate of return =10%

So,Cost of equity= 4.5%+ 0.44* (10%-4.5%)

= 6.93%

As there is no debt, the cost of equity is the same as cost of capital

Hence, cost of capital of Identical Twin Beer Co is 6.93%