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An unregulated company wishes to determine its cost of capital. It knows that in order to do so it must have a cost rate to
An unregulated company wishes to determine its cost of capital. It knows that in order to do so it must have a cost rate to its invested capital and, therefore, considers it appropriate to use the CAPM model to determine this cost. Its structure includes the following: Debt 450.000.000 Equity 550.000.000 Total 1.000.000.000 The cost of debt amounts to 11%. Some data that have been collected so far are: (a) Average market (stock market) return (rm): 2014 17% 2015 13% 2016 15% (b) Risk-free rate (rf) for the last few years 2014 3.25% 2015 3.875% 2016 4.25% (C) Risk-free rate (rf) 5% (d) Beta indicator 0.87 In addition, an income tax rate of 25% is considered. Therefore, the following is requested: 1.- Calculate the expected rate of return according to CAPM model, using the average profitability of the last 3 years, and the market risk free rate, considering also the average rate of the last 3 years. Since it is a regulated company, an additional country risk rate (rp) of 3.2% must be added at the end of the formula. Considering then: re = rf + beta*(rm -rf) + rp 2. Using the CAPM as the required rate of return on equity calculate the WACC 3. If the company has a possible investment with an expected return of 15%, is it advisable to accept the investment? 4. Comment on beta of 0.87
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