A company, based in the US, wants to calculate its cost of capital and gives you the following data:

• Risk-free rate (T-Bonds) Rf 2%
• Equity Market Risk-Premium (EMRP) US 6%
• Systematic risk coefficient (ß)           1.25
• Financial debt risk-premium 1%
• Corporate tax rate (CTR)          33% (1/3)
• Share of equity in the financing            80%

Let me remind you the main formulas:

WACC = EQ(%) * E(ROE) + D(%) * Id * (1 – CTR)

EQ(%) and D(%) respectively represent the share of equity and net financial debt in the financing of capital employed, Id is the debt interest rate and CTR the corporate tax rate.

E(ROE) = Fry + ß * EMRP

Fry is the risk-free rate of return, ß the systematic risk coefficient of the firm (its sensitivity to macro-economic conditions) and EMRP the equity market premium, i.e. the return investors expect out of a diversified portfolio of shares on top of the risk-free rate.

This exercise is linked to the vertical video Module 5, “The Cost of Capital”.