Help about WACC calculation

urgen Knudsen has been hired to provide industry expertise to Henrik Sandell, CFA, an analyst for a pension plan managing a global large-cap fund internally. Sandell is concerned about one of the fund’s larger holdings, auto parts manufacturer Kruspa AB. Kruspa currently operates in 80 countries, with the previous year’s global revenues at €5.6 billion. Recently, Kruspa’s CFO announced plans for expansion into Trutan, a country with a developing economy. Sandell worries that this expansion will change the company’s risk profile and wonders if he should recommend a sale of the position.

Equity risk premium, Sweden 4.82 percent
Risk-free rate of interest, Sweden 4.25 percent
Industry debt-to-equity ratio 0.3
Market value of Kruspa’s debt €900 million
Market value of Kruspa’s equity €2.4 billion
Kruspa’s equity beta 1.3
Kruspa’s before-tax cost of debt 9.25 percent
Trutan credit A2 country risk premium 1.88 percent
Corporate tax rate 37.5 percent
Interest payments each year Level

Using the capital asset pricing model, Kruspa’s cost of equity capital for its typical project is closest to:

  1. 7.62 percent.
  2. 10.52 percent.
  3. 12.40 percent

i dont get it why the answer doesnt include contry premium since this question is talking about invest in anouther country.

Very good question indeed . These are the type of qs. that fox a candidate to an commit error. I will try to qualify the qs. first. The answer is already known to you. It is 10.512, option B I suppose.

Amidst the labyrinth of data which you will need to discard : the key word out here is “typical” and another aspect is, Kruspa is the yet to act on the expansion in Truta country while the manager is already invested. His decision is to divest or atleast cut down the already invested funds.

Hence it is absolutely right not to consider the possible target cost of equity but the present one.

However, the qs. is still a little bit confusing… it says “expansion “ not explicitly mentions greenfield. The approach to calculate the reqd. return from the CAPM model is absolutely right if it is a greenfield one but with expansion there does exists an element of doubt. But even that is ironed out because a “typical” cost of equity is asked.

You are welcome.