Smaltz Enterprises is currently involved in its annual review of the firm's cost of capital.Historically, the firm has relied on theCAPMto estimate its cost ofequitycapital.The firm estimates that its equitybetais 1.25, and the current yield on long-term U.S. Treasury bonds is 4.28%. The firm's CFO is currently in a debate with one of the firm's advisors at its investment bank about the level of the equity risk premium. Historically, Smaltz has used 7% to approximate the equity risk premium. However, the investment banker argues that this premium has shrunk dramatically in recent years and is more likely to be in the 3% to 4% range.

a.Estimate Smaltz's cost of equity capital using a market risk premium of 3.5%.

b.Smaltz'scapital structureis comprised of 75% equity (based on current market prices) and 25% debt on which the firm pays a yield of 5.125% before taxes at 25%.

c.What is the firm'sWACCunder each of the two assumptions about the market risk premium?

NOTE: PLEASE USE EXCEL TEMPLATE ATTACHED.

PROBLEM 4-6 Given Levered equity beta Treasure bond yield Market risk premium Tax rate Debt as % of Capital Structure Solution Legend 1.25 4.28% 3.50% 25.00% 25.00% = Value given in problem = Formula/Calculation/Analysis required 7.00% = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output Solution a. Cost of equity b. Low ERP High ERP WACC with Low ERP Cap Str After-Tax Weights Costs Product Debt 25.00% Equity 75.00% WACC with High MRP Cap Str After-Tax Weights Cost Product Debt 25.00% 75.00% Equity