Question

Vision Inc. is financed through both debt and equity, with a D/E ratio of 0.75. The firm’s overall risk is measured at a beta of 1.3 with a cost of equity of 12 percent. The risk-free rate of return is 2.5 percent and the tax rate is 30%. The company’s debt consists of semiannual bonds, with a coupon rate of 10%. They have 10 years to maturity and currently sell for $1,000.

Answer 1

Answer: Returns using CAPM = 14.85%,  Weighted Average Cost of Capital = 8.25%

Explanation:

The question is unclear with regards to the requirements, it is not clear what the question requires us to do, However after carefully assessing information provided in the question and also drawing from my past experience  with questions of this nature we can assume that the  questions requires Weighted Average Cost of Capital and/ or Return calculation using Capital  Asset Pricing model.

We will start with Capital Asset Pricing Model Returns Calculation

Risk Free rate of return (Rf) = 2.5%

Firm's overall risk/Company Beta (β) = 1.3

Cost of Equity (shareholders rate of return on equity denoted by R) = 12%

Returns = Rf + β(R - Rf)

Returns = 2.5 + 1.3(12 - 2.5)

Returns = 2.5 + 12.35

Returns = 14.85%

Weighted Average Cost of Capital (WACC) Calculation

Debt Equity Ratio = 0.75, Debt is 75%, 25% equity

Cost of Equity = 12%

Cost of Debt (Rd) = 10%

Tax rate= 30%

WACC = E/(D+E) x Re + Rd x (1 - t)D/(D+E)

WACC = 0.25 x 12% + 10% x (1 - 0.3)(0.75)

WACC = 3% + 5.25%

WACC = 8.25%

Answer 2

Answer:

Cost of Capital 14.85%

WACC 8.97%

Explanation:

As the bonds sale at par their effective rate matches the coupon rate os 7.5%

the equity cost of capital is solve through CAPM:

$Ke= r_f + \beta (r_m-r_f)$

risk free = 0.025

market rate = 0.12

premium market = (market rate - risk free) 0.095

beta(non diversifiable risk) = 1.3

$Ke= 0.025 + 1.3 (0.095)$

Ke 0.14850

And now, we solve for WACC

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

Ke 0.14850

Equity weight 0.25

Kd 0.1

Debt Weight 0.75

tax rate 0.3

$WACC = 0.1485(0.25) + 0.1(1-0.3)(0.75)$

WACC 8.96250%