Question

Maxwell Electronics, a consumer electronics company, plans to expand its operations in the Asia- Pacific region. The company has debt of $4 million and assets worth $14 million. Cuprum Electricals Inc., the market leader, has similar revenue, net income, and business risk. The information of the two companies is as follows: Debt of Cuprum Electricals Inc. Equity of Cuprum Electricals Inc. Levered beta of Cuprum Electricals Inc. Marginal tax rate Risk-free rate Market risk premium $7 million $35 million 0.8 40% 5% 10% Based on the information provided, calculate the cost of equity of Maxwell Electronics. 10.76%. 13.86% 13.37%

Answer 1

Unlevered beta = Levered beta / (1 + (1 - tax) x D/E)

= 0.8 / (1 + (1 - 40%) x 7 / 35)

= 0.7

Beta for Maxwell = Unlevered beta x (1 + (1 - tax) x D/E) = 0.7 x (1 + (1 - 40%) x 4 / 10) = 0.89

Cost of equity = Rf + beta x MRP = 5% + 0.89 x 10% = 13.86%