Glassmaker has pre-merger $5 in debt and $10 in equity. Rate on debt is 11%. The risk free rate is 6%. The tax rate is 40% . The levered beta is 1.36. The equity risk premium is 4%. What discount rate should you use to discount Glassmakers' free cash flows and interest tax savings?

The answer is 11.44%

Explanation:

Solution

Given that:

Glass maker has a pre-merger of =$5 debt

Equity =$10

The rate on debt =11%

The risk free rate =6%

Tax rate =40%

The levered beta is =1.36

Equity risk premium is= 4%.

Now,

the next step is to find discount to use for Glass maker free cash flows and interest tax savings

Cost of equity (Ke) =  Risk free return + Beta ( Market return - Risk free return )

= 6% +1.36( 10%-6%)

=11.44%

Therefore, the rate to be used to discount free cash flows and interest tax savings is 11.44%

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