1. XYZ's current capital structure is comprised of 20% debt and 80% equity (based on market values). XYZ's equity beta (based on its current level of debt ?nancing) is 1.25, and its debt beta is 0.35. Also, the risk-free rate of interest is currently 4% on long-term government bonds. XYZ's investment banker advised the ?rm that, according to her estimates, the market risk premium is 5.5%.
a. What is your estimate of the cost of equity capital for XYZ (based on the CAPM)?
b. If XYZ's marginal tax rate is 35%, what is the ?rm's overall weighted average cost of capital (WACC)?
c. XYZ is considering a major expansion of its current business operations. The ?rm's investment banker estimates that XYZ will be able to borrow up to 40% of the needed funds and maintain its current credit rating and borrowing cost. Estimate the WACC for this project.