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%