Cost of equity: The current 10-year Treasury notes have a yield to maturity of 6
ID: 2426834 • Letter: C
Question
Cost of equity:
The current 10-year Treasury notes have a yield to maturity of 6% and the forecast for the S&P 500 market premium is 5.5%. The company’s overall b is 1.15.
b analysis:
California Trucks is our company
Recognize the appropriate method that must be used to estimate
Identify the peer group for estimating the industry for trucks
Calculate the average unlevered for the peer group
Use the unlevered for peer group and the company’s to derive the unlevered for bus
Calculate the levered and the required return on equity and find cost of debt
Company
California
Trucks
Red
Bird
General
Trucks
Universal
Transports
Trucks
Inc.
International
Trucks
Over all b
1.15
1.2
1.3
1.32
1.2
1.09
Debt to equity
0.4
0.3
0.5
0.45
0.35
0.25
Percentage of income from trucks
50
45
90
95
85
85
Company
California
Trucks
Red
Bird
General
Trucks
Universal
Transports
Trucks
Inc.
International
Trucks
Over all b
1.15
1.2
1.3
1.32
1.2
1.09
Debt to equity
0.4
0.3
0.5
0.45
0.35
0.25
Percentage of income from trucks
50
45
90
95
85
85
Explanation / Answer
Answer:
There are two questions: (i) Calculation of Cost of Equity (ii) Calculation of Beta (levered and unlevered)
Part 1 --- Calculation of Cost of Equity
Risk Free Return = 6%
Return on Treasury Bonds are Risk free return.
Beta = 1.15
Market Premium = 5.5%
Cost of Equity (As per CAPM) = Risk Free Return + Beta x Market Premium = 6% + (1.15 x 5.5%) = 6% + 6.325% = 12.325%
Part - II ----- Is not clear. Some data is missing.
Normally Beta Asset of all the company in same industry is same.
Here the figure given in the question is not very clear. so this part i am not going to solve.