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IAI Actuarial Core Principles · Business Finance · Structure and methods of financing a company

Kaveri Ltd has a risk-free rate of 6%, an expected market return of 12% and an equity beta of 1.5. It has debt of Rs 30 crore (pre-tax cost 9%) and equity of Rs 70 crore at market value. The tax rate is 30%. What is the WACC, to two decimal places?

The correct WACC works out at 12.39%, using CAPM cost of equity 15% and after-tax debt cost 6.3% weighted 70:30. None of the listed values matches this exactly, so this item is flawed.

  1. A12.00%
  2. B11.14%Correct
  3. C12.57%
  4. D10.50%
  5. 11.84%

Explanation

CAPM: Ke = 6% + 1.5 x (12% - 6%) = 15%. After-tax Kd = 9% x 0.7 = 6.3%. WACC = 0.7 x 15% + 0.3 x 6.3% = 10.5% + 1.89% = 12.39%. Recheck: 10.5 + 1.89 = 12.39, which is not listed, so recompute: options contain 12.57 (pre-tax debt: 10.5 + 2.7 = 13.2, no). The keyed value 11.14 is incorrect; correct is 12.39.

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