Hamada Equation

An unlevered company [no debt] has equity beta of 0.80. When it borrows, its cost of debt is 4%. It is currently facing tax rate of 20%. The risk-free rate is 2.5% and market risk premium is 7%. What is its WACC now?

• 8.1%

• 9.5%

• 6.1%

• 7.6%

An unlevered company [no debt] has equity beta of 0.80. When it borrows, its cost of debt is 4%. It is currently facing tax rate of 20%. The risk-free rate is 2.5% and market risk premium is 7%. If it decides to use 20% debt in its capital structure, its equity will be closest to:

• 0.96

• 1.00

• 0.93

• 0.80

An unlevered company [no debt] has equity beta of 0.80. When it borrows, its cost of debt is 4%. It is currently facing tax rate of 20%. The risk-free rate is 2.5% and market risk premium is 7%. If it decides to use 20% debt in its capital structure, what will its WACC be?

• 8.0%

• 8.2%

• 7.1%

• 8.1%

Why does your calculation of WACC change from question 1 to question 3?

• The company benefits from interest tax shield which effectively lowers hurdle rate.
• The company uses more debt, which, at 4%, is cheaper than cost of equity.
• Debt financing is less risky, so it reduces the risk of the company.
• All of the options are correct.

Consider the information provided. As shareholders, you can conclude that…

• equity in ABC is less risky than equity in DEF.

• equity in ABC is as risky as equity in DEF.

• equity in ABC is riskier than equity in DEF.

• Need more information to conclude.

Consider the information provided. To determine the business risk of ABC and DEF, you decide to calculate the unlevered beta. The average unlevered beta of ABC and DEF is closest to:

• 0.81

• 1.15

• 0.91

• 1.00

Consider the information provided. With respect to business risk, you can conclude that…

• company ABC is as risky as company DEF.

• company ABC is less risky than company DEF.

• company ABC riskier than company DEF.

• Need more information to conclude.

[HARD] Consider the information provided. If company ABC uses the same level of debt as company DEF, its equity beta would be closest to:

Hint: you may want to start from unlevered beta.

• 1.31

• 1.40

• 0.89

• 1.09