Question

Thunderhorse Oil is a U.S. oil company. Its current cost of debt is 7.00​%, and the​ 10-year U.S. Treasury​ yield, the proxy for the​ risk-free rate of​ interest, is 3.60​%. The expected return on the market portfolio is 8.20​%. The​ company's effective tax rate is 39​%. Its optimal capital structure is 45% debt and 55​% equity.

1. If​ Thunderhorse's beta is estimated at 0.70​, what is​ Thunderhorse's weighted average cost of​ capital?

2.If​ Thunderhorse's beta is estimated at 0.20​, significantly lower because of the continuing profit prospects in the global energy​ sector, what is​ Thunderhorse's weighted average cost of​ capital?

Answer 1

Part 1: calculation of WACC Financing after tax cost market value weighted cost working for part 1 after tax cost of Debt-796"(1-0.39) cost of equity-risk free rate+beta*(market return-risk free rate) 0.036+0.7*(0.082-0.036) 4.27% 6.82% 45% 55% Debt 4.27% 6.82% 1.92% 3.75% 5.67% equity WACC Part 2: calculation of WACC Financing working for part 2 after tax cost of Debt-796"( 1.0.39) cost of equity-risk free rate+beta*(market return-risk free rate) 0.036+0.2 (0.082-0.036) 4.27% after tax cost*market value weighted cost 14.52% C-a"b Debt 4.27% 45% 1.92% 2.49% 4.41% equity 4.52% 55% WACC