A firm has a capital structure containing 60 percent debt and 40 percent common stock equity. Its outstanding bonds offer investors a 6.5 percent yield to maturity. The risk-free rate currently equals 5 percent, and the expected risk premium on the market portfolio equals 6 percent. The firm’s common stock beta is 1.20.
a. What is the firm’s required return on equity?
b. Ignoring taxes, use your finding in part a to calculate the firm’s WACC.
c. Assuming a 40 percent marginal tax rate, recalculate the firm’s WACC found in part b.
d. Compare and contrast the values for the firm’s WACC found in parts b and c.