Question: Suppose that you work as an equity analyst at an investment bank. You need to find a weighted average cost of capital for a firm,

Suppose that you work as an equity analyst at an investment bank. You need to find a weighted average cost of capital for a firm, which you will use in your valuation model. You found the following information for this firm:

- It is financed with equal amount of debt and equity, i.e. its debt-to-equity ratio is 1

- Its cost of debt is 4.5%

- The equity beta is 1.4

The economic forecasting division of your bank advises you to use a market risk premium of 5% and a risk-free rate of 4% in your model. Suppose that the assumptions of the Modigliani-Miller theorem hold. In particular, assume that corporations do not pay corporate income taxes. What is the weighted average cost of capital of this firm?

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