Q. Maxwell ltd. Common stock beta is 1.2 and the debt/equity ratio is 0.7. The corporation tax rate is 30 %. If risk free return is 6% and market risk premium is 5% then what is the required rate of return on total assets of the company? A. 12.20% B. 15.73% C. 9.83% D. 9.24% I think required rate of return means "CAPM cost of equity". But it doesnt work. The "total assets" part confuses me.
I would be calculating the WACC. The amount of debt is 0.7. Amount of equity is 1. Total assets = 1.7 The required return on equity is 6% + 1.2 x 5% = 12% Not sure what rate to use for debt. If you can borrow at the risk-free rate then net cost of debt = (1-30%) x 6%= 4.2% So WACC = 8.79% - sorry, not one of the options! Obviously can't borrow at the risk-free rate??
Thats my dilemma. None of the options seem to fit. The answer is 9.83%. Unfortunately, the IAI solutions do not post explanation of multiple choice answers, only the answers.
all i can say is return on assets is different from wacc...i came across one of the IAI papers...but now dont remember..........its a lil logical instead of calculative.....
Required rate of return is the same as the CAPM cost of equity. I dont know any other interpretation of total assets other than the total of assets column of balance sheet. Current Assets + Non current assets. But no information about that in the question. Plus, anyone know the what does "common stock beta" denote? Is it the ungeared beta or geared?
Even if I assume the beta is ungeared and then convert to a geared beta, I don't get any of the options!
Yeah. It comes out to be 10.52%. I thought it would be nice if any of the AcEtd Tutors might try this.
