Amgel manufacturing Company's current capital structure is comprised of 30% debt and 70% equity (based on market values). Amgel's equity beta (based on its current level of debt financing) is 1.20, and the debt beta is 0.29. Also, the risk-free rate of interest is currently 4.5% on long-term government bonds. Amgel's investment banker advised the firm that, according to her estimates, the market risk premium is 5.25%. a. What is your estimate of the cost of equity capital for Amgel (based on the CAPM)? b. If Amgel's marginal tax rate is 35%, what is the firm's overall weighted average cost of capital (WACC)? c. Amgel is considering a major expansion of its current busness operations. The firm's investment banker estimates that Amgel 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.

PROBLEM 5-2 Given Debt Ratio (current) Equity Ratio (current) Cost of Debt Market Risk Premium Equity Beta Debt Beta Risk Free Rate Corporate Tax Rate Solution Legend 30.0% 70.0% 6.0% 5.25% 1.20 0.29 4.5% 0.35 Solution a. Cost of Equity b. WACC c. Unlevered beta (current debt levels) Revised Equity Beta Cost of Equity Debt Ratio Equity Ratio Revised WACC 40.0% = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output Note: This analysis presumes that the cost of debt financing is "sticky" in the sense that it varies in a discrete fashion with the firm's bond rating. In other words, even though the firm has increased its use of financial leverage from 35 to 40% the cost of debt (and the debt beta) do not change.bOn the other hand, the cost of equity does change since the higher leverage implies a higher equity beta