Question

Calculate the cost of capital for operations (WACC) for ACME, Inc. Use the capital asset pricing model to

estimate the cost of equity capital.

     U.S. Government long-term bond rate                           2.25%

     Market risk premium                                                       5.50%

     Equity beta                                                                      1.20

     Per-share market price                                             $100.00

     Shares outstanding                                                       12.5 million

     Net financial obligations on balance sheet               $750.5 million

     Weighted-average borrowing cost                                  6.0%

     Statutory tax rate                                                           35.0%

3.  Given your answer above in 2 and equation 14.6 from the Penman textbook, it appears that the cost of capital for operations, ρ_F, is a function of the cost of equity capital, ρ_E. Does the equity cost of capital determine the firm’s cost of capital? Explain briefly.

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