Question

The common stock of Clear Channel Communications (CCU) in San Antonio has a beta of 1.2. The current T-Bill rate is yielding 4% and the market risk premium is estimated to be at 10% (or 10% above the expected return in the market). CCU’s capital structure is 40% debt paying 7%, 60% equity. Their tax rate is 30%. What is CCU’s equity cost of capital? What is CCU’s WACC? CCU is evaluating whether to invest in a tower project. If the tower project can generate over $200,000 per year for 10 years, what is the max CCU should be willing to invest to start this project?

Answer 1

Risk free rate	4%
Risk premium	10%
Beta	1.2
Cost of equity=	Risk free rate + Beta * Market risk premium
Cost of equity=	4%+1.2*10%
Cost of equity=	16.00%
Calculation of WACC
	Cost	Effecetive Cost	Effecetive Cost	Weight	Weighted cost
			A	B	C=A*B
Debt	7.00%	7%*(1-30%)	4.90%	40.00%	1.96%
Equity	16.00%	16%*(1-0)	16.00%	60.00%	9.60%
	Total capital			Total WACC	11.56%
Annual cash flow	$         200,000
WACC	11.56%
Period in years	10
PV of annuity
P = PMT x (((1-(1 + r) ^- n)) / r)
Where:
P = the present value of an annuity stream	P
PMT = the dollar amount of each annuity payment	$         200,000
r = the effective interest rate (also known as the discount rate)	11.56%
n = the number of periods in which payments will be made	10
So maximum amount payable will be the PV of this cashflow stream=	PMT x (((1-(1 + r) ^- n)) / r)
So maximum amount payable will be the PV of this cashflow stream=	200000*(((1-(1 + 11.56%) ^- 10)) / 11.56%)
So maximum amount payable will be the PV of this cashflow stream=	$ 1,150,692.31