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Question - 2: [10+5+10=25] Suppose a company uses only debt and equity to finance its capital budget and uses CAPM to compute its cost


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Question - 2: [10+5+10=25] Suppose a company uses only debt and equity to finance its capital budget and uses CAPM to compute its cost of equity. Company estimates that its WACC is 12%. The capital structure is 75% debt and 25% equity. The before tax cost of debt is 12.5% and the tax rate is 20%. Risk free rate is = 6% and the market return = 14%: a) What is the beta of the company? Olympic Industries has a Debt to Equity (D/E) ratio is 50%. The cost of Debt is 8% and the cost of equity is 13%. The tax rate is 40%. b) What is the weighted average cost of capital (WACC) for Olympic Industries ? Trump Hotels currently has $10 million face value of bonds that have five years remaining to maturity, 8 percent coupon with semi-annual payments, and are currently valued at 7.99 Million in total. It also has 1.2 million common shares of stock outstanding and the stock has a beta of 2.2. If Trump Hotels issues up to $2.5 million of new bonds, the bonds will be priced at par and have a yield of 13.65 percent; but if it issues bonds beyond $2.5 million, the expected yield on the entire issuance will be 16 percent. Donald Trump has learned that it can issue new common stock at $10 per share. The current risk-free rate of interest is 3 percent and the expected market return is 10%. Trump's marginal tax rate is 30 %. c) If Trump wants to raise $7.5 million of new capital while maintaining the same debt-to-equity ratio as it currently has, what will be its weighted average cost of capital (WACC)?

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