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Weighted average cost of capital of Firm:
Security
Beta
Expected return
Market
Risk-free
Firm A
Firm B
1.0
0.0
( )
2.0
8.0%
4.0%
10.0%
( )%
1) Figure out the beta for Firm A.
2) Suppose that Firm B has a beta of 2. In addition, Firm B has outstanding long-term bonds. Firm A's Debt-to-Equity ratio (D/E) is 100%. The current yield-to-maturity is 4%. The tax rate is 40%.
i) Figure out the cost of equity for Firm B using CAPM.
ii) Figure out the weighted average cost of capital of Firm B (WACC).
3) What is the relationship between the WACC and capital budgeting? In other words, how does the WACC affect capital budgeting?
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