Step 1: Required Rate of Return on Equity Using CAPM

CAPM Formula:

RequiredRateofReturnonEquity=Rf+(MarketRiskPremium)

Where:

• Rf=4.0%=0.04 (Risk-free rate),
• =1.10 (Beta),
• Market Risk Premium = 6.0%=0.06.

Substitute the values:

RequiredRateofReturnonEquity=0.04+1.100.06

RequiredRateofReturnonEquity=0.04+0.066=0.106or10.6%

Step 2: Weighted Average Cost of Capital (WACC)

WACC Formula:

WACC=(E/V)Re+(D/V)Rd(1TaxRate)

Where:

• E/V=60%=0.60 (Weight of equity),
• Re=10.6%=0.106 (Required rate of return on equity),
• D/V=40%=0.40 (Weight of debt),
• Rd=4.0%=0.04 (After-tax cost of debt).
• Confirm the calculations, or explain a correction to the calculation in the initial post.
• Compare how your calculated WACC is different than your classmate's calculated WACC.
• Explain how the different WACCs would impact the net present value of the Electrobicycle project.

Substitute the values:

WACC=(0.600.106)+(0.400.04)

WACC=0.0636+0.016=0.0796or7.96%

Final Results:

• Required Rate of Return on Equity: 10.6%
• Weighted Average Cost of Capital (WACC): 7.96%

Explanation:

1. Why Use WACC to Value the Electrobicycle Project:
   • WACC reflects the company's overall cost of capital, accounting for both debt and equity financing. It represents the blended cost of financing the project and is appropriate for valuing projects that align with the company's capital structure and risk profile.
   • Using WACC ensures that the valuation incorporates the benefits of cheaper debt financing and the equity cost.
2. Comparison to Using Only the Cost of Equity:
   • Using only the cost of equity (10.6%) would overestimate the required return, as it ignores the lower cost of debt financing.
   • WACC provides a more balanced measure, as it considers the mix of debt and equity, making it a more accurate benchmark for project valuation.

By valuing the Electrobicycle project using WACC, Optimus ensures that the valuation reflects its actual financing costs, leading to better-informed investment decisions.