Cabana Cruise Line offers cruise ship service to various tropical locations throughout the globe. The company is considering the addition of a new cruise ship to its fleet in order to expand service to new destinations by serving additional patrons. The project involves commissioning a new ship, developing destination ports to accommodate the ship, and promotion of the new destinations. The company uses its WACC as the hurdle rate to be met for new projects. However, since a new project has not been considered in some time, the WACC for the company needs to first be recalculated. Cabana Cruise Line uses a combination of debt and equity to fund operations, and they have a bond rating of A. Market capitalization consists of 12 million shares outstanding and currently trades at a value of $51 per share. Cabana Cruise Line has outstanding debt of $150 million, a default rate of 0.10%, and has a 40% tax rate. Additional information is provided in the tables below. Cost of Equity Cost of Debt Risk Free Return Rate 4% Market Return 8% Probability of Default Debt yield to maturity 2% 5% Company Return 10% Loss Rate 40% Beta 1.05 Beta 0.95 Using the data provided,

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Cost of Equity
Cost of Debt
Risk Free Return Rate
4%
Probability of Default
2%
Market Return
8%
Debt yield to maturity
5%
Company Return
10%
Loss Rate
40%
Beta
1.05
Beta
0.95
Using the data provided,
1. Apply CAPM to determine the cost of equity and the cost of debt for Cabana Cruise Line.
2. Apply WACC to determine the hurdle rate that should be used by Cabana Cruise Line.
Cost of Equity
Required return of security i = risk free rate + Beta x (value of equity [return of market] - risk free rate)
T₁ =rf+ B₁x (E [Rmkt] -rf
Cost of Equity =
Cost of Debt
ra = yield to maturity - probability of default x expected loss rate
Cost of Debt =
WACC
=
Rate WACC [Equity / (Equity + Debt)]x rate of equity + [Debt/ (Equity + Debt]] x Rate of debt x (1 - tax rate)
RWACC [E/ (E+D)] x RE+[D/ (E+D)] x Rpx (1-RTax)
WACC =
Transcribed Image Text:Cost of Equity Cost of Debt Risk Free Return Rate 4% Probability of Default 2% Market Return 8% Debt yield to maturity 5% Company Return 10% Loss Rate 40% Beta 1.05 Beta 0.95 Using the data provided, 1. Apply CAPM to determine the cost of equity and the cost of debt for Cabana Cruise Line. 2. Apply WACC to determine the hurdle rate that should be used by Cabana Cruise Line. Cost of Equity Required return of security i = risk free rate + Beta x (value of equity [return of market] - risk free rate) T₁ =rf+ B₁x (E [Rmkt] -rf Cost of Equity = Cost of Debt ra = yield to maturity - probability of default x expected loss rate Cost of Debt = WACC = Rate WACC [Equity / (Equity + Debt)]x rate of equity + [Debt/ (Equity + Debt]] x Rate of debt x (1 - tax rate) RWACC [E/ (E+D)] x RE+[D/ (E+D)] x Rpx (1-RTax) WACC =
Cabana Cruise Line offers cruise ship service to various tropical locations throughout the globe. The company is considering the addition of a new
cruise ship to its fleet in order to expand service to new destinations by serving additional patrons. The project involves commissioning a new ship,
developing destination ports to accommodate the ship, and promotion of the new destinations. The company uses its WACC as the hurdle rate to be
met for new projects. However, since a new project has not been considered in some time, the WACC for the company needs to first be recalculated.
Cabana Cruise Line uses a combination of debt and equity to fund operations, and they have a bond rating of A. Market capitalization consists of 12
million shares outstanding and currently trades at a value of $51 per share. Cabana Cruise Line has outstanding debt of $150 million, a default rate of
0.10%, and has a 40% tax rate. Additional information is provided in the tables below.
Cost of Equity
Cost of Debt
Risk Free Return Rate
4%
Probability of Default
2%
Market Return
8%
Debt yield to maturity
5%
Company Return
10%
Loss Rate
40%
Beta
1.05
Betal
0.95
Using the data provided,
1. Apply CAPM to determine the cost of equity and the cost of debt for Cabana Cruise Line.
2. Apply WACC to determine the hurdle rate that should be used by Cabana Cruise Line.
Cost of Equity
Required return of security i-risk free rate + Beta x (value of equity [return of market] - risk free rate)
nry+ B₁x (E [Rakt]-ry
Cost of Equity=
Cost of Debt
ra = yield to maturity-probability of default x expected loss rate
Cost of Debt =
Transcribed Image Text:Cabana Cruise Line offers cruise ship service to various tropical locations throughout the globe. The company is considering the addition of a new cruise ship to its fleet in order to expand service to new destinations by serving additional patrons. The project involves commissioning a new ship, developing destination ports to accommodate the ship, and promotion of the new destinations. The company uses its WACC as the hurdle rate to be met for new projects. However, since a new project has not been considered in some time, the WACC for the company needs to first be recalculated. Cabana Cruise Line uses a combination of debt and equity to fund operations, and they have a bond rating of A. Market capitalization consists of 12 million shares outstanding and currently trades at a value of $51 per share. Cabana Cruise Line has outstanding debt of $150 million, a default rate of 0.10%, and has a 40% tax rate. Additional information is provided in the tables below. Cost of Equity Cost of Debt Risk Free Return Rate 4% Probability of Default 2% Market Return 8% Debt yield to maturity 5% Company Return 10% Loss Rate 40% Beta 1.05 Betal 0.95 Using the data provided, 1. Apply CAPM to determine the cost of equity and the cost of debt for Cabana Cruise Line. 2. Apply WACC to determine the hurdle rate that should be used by Cabana Cruise Line. Cost of Equity Required return of security i-risk free rate + Beta x (value of equity [return of market] - risk free rate) nry+ B₁x (E [Rakt]-ry Cost of Equity= Cost of Debt ra = yield to maturity-probability of default x expected loss rate Cost of Debt =
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