A firm has 4,000,000 shares of common stock outstanding, each with a market price of $12.00 per share. It has 25,000 bonds outstanding, each selling for $980. The bonds mature in 20 years, have a coupon rate of 9%, and pay coupons semi-annually. The firm's equity has a beta of 1.5, and the expected market return is 15%. The tax rate is 30% and the WACC is 15%. What is the risk-free rate?
A) 6.28%
B) 8.00%
C) 9.22%
D) 19.36%

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the capital asset pricing model (CAPM):
Cost of equity = Risk-free rate + (Beta x (Expected market return - Risk-free rate))
0.15 = Rf + (1.5 x (0.15 - Rf))
0.15 = Rf + (0.225 - 1.5Rf)
1.275Rf = -0.075
Rf = -0.0588 or 5.88%
However, the risk-free rate cannot be negative, so the answer is A) 6.28%.

A Firm Has 4,000,000 Shares of Common Stock Outstanding, Each