Determine the weighted average cost of capital

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Reference no: EM133326864

Case: In 1999, Amazon Inc. is considering launching a new e-commerce business specializing in cloud computing services. The project is tentatively named Amazon Web Services (henceforth "AWS"). To assess the feasibility of AWS, Amazon's CFO has identified Oracle Corp. (NYSE: ORCL) as a comparable firm that has similar business risk and estimated the following information:

• Oracle has equity and debt, respectively, worth $20 billion and $40 billion.

• Oracle's equity beta and debt beta, respectively, are estimated at 1.8 and 0.1.

• Oracle's marginal tax rate is estimated at 25%.

Amazon CFO is trying to determine the weighted average cost of capital for AWS. He believes that Amazon's cost of debt will apply to AWS's debt financing. The CFO's estimate of the CAPM beta of Amazon's debt is 0.2. AWS is expected to maintain a target leverage ratio of 50% and face a marginal tax rate of 20% in the foreseeable future. Assume that the risk-free rate is 5% and the market risk premium is 10%.

Answer questions a) and b) below.

Question 1: To help Amazon CFO complete his analysis, calculate the unlevered asset beta.

Question 2: Determine the weighted average cost of capital (WACC) for AWS. In case you are unsure about your results in part a, assume that unlevered asset beta βu = 1.0.

Reference no: EM133326864

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