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Homework answers / question archive / A corporation has 60,000 shares of common stock outstanding at a market price of $24 per share
A corporation has 60,000 shares of common stock outstanding at a market price of $24 per share. The firm has also 4,000 bonds outstanding currently selling for $960 each. The stock beta of the company is 1.25 and the market risk premium is 7.2%. The T-bill rate of return is 4.5%. Assume that the company’s cost of debt is 6% and the tax rate is 33%. Estimate the cost of capital.
COST OF EQUITY = RISK FREE RATE + BETA x (MARKET RISK PREMIUM)
= 4.5% + 1.25 x (7.2%)
= 4.5% + 9%
= 13.5%
COST OF DEBT = COST OF DEBT x (1-TAX RATE)
= 6% x (1-0.33)
= 6% x 0.67
= 4.02%
TOTAL WORTH = 60,000 x 24 + 4,000 x 960
=1,440,000 + 3,840,000
= 5,280,000
WEIGHT OF DEBT = 3,840,000 / 5,280,000
= 0.73
WEIGHT OF EQUITY = 1 -0.73
= 0.27
WACC = 0.73 x 4.02% + 0.27 x 13.5%
= 2.93 + 3.64
= 6.57%
