Beta (Levered) Exercise (Please Help)
I have the following question and would appreciate if you could tell me if I get it correct:
I am trying to calculate the Required return for a company that introduces Debt in its capital structure.
At the beginning the company is Equity only and has beta (unlevered) of 1.2. The Risk free rate is 6% and the Market Premium is also 6%.
Under this basis the firm's (all equity) required return is (under CAPM) Cost of Equity = 0.06 + 0.06 x 1.2 = 13.2%
The company then introduces 60% debt at 11% pricing of Debt and I am required to find the new Cost of Equity and WACC. Assume No Taxes.
To do so, first I lever up the beta as follows:
Beta (Levered) = Beta unlevered x ( 1 + D/E) = 1.2 x [1 + (60/40)] = 1.2 x 1.5 = 3
The required rate of return is then (under CAPM) = 0.06 + 3 x 0.06 = 24%.
PLEASE Let me know if you think I am doing a mistake anywhere in my calculations or approach above.
I am then using the 24% to calculate the WACC of the firm:
WACC = 0.24 x (40/100) + 0.11 x (60/100) = 16.2
Thank you in advance
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