Problem:

A firm has capital structure containing 60% debt and 40% common stock equity. Its outstanding bonds offer investors as 6.5% yield to maturity. The risk-free rate currently equals 5%, and the expected risk premium on the market portfolio equals 6%. The firm's common stock beta is 1.20.

Required:

Question 1: What is the firm's required return on equity?

Question 2: Ignoring taxes, use your finding in part (a) to calculate the firm's WACC.

Question 3: Assuming a 40% tax rate, recaluculate the firm's WACC found in part (b).

Question 4: Compare and contrast the values for the firm's WACC found in parts (b) and (c).

Note: Provide support for your rationale.