Assume that you have been hired as a consultant by CGT, a major producer of chem
ID: 2627324 • Letter: A
Question
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
$38,000,000
$101,000,000
$139,000,000
Liabilities and Equity
$10,000,000
$9,000,000
$19,000,000
$40,000,000
$59,000,000
$30,000,000
$50,000,000
$80,000,000
$139,000,000
The stock is currently selling for $15.00 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $1,150.00. The beta is 1.35, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.
Based on the CAPM, what is the firm's cost of equity?
13.60%
15.64%
16.73%
11.56%
10.20%
Current assets$38,000,000
Net plant, property, and equipment$101,000,000
Total assets$139,000,000
Explanation / Answer
Rs = Rrf + b(Rm - Rrf)
Rrf = risk free rate = 5.5%
Rm = Expected Return on Market = 11.50%
b = beta = 1.35
Rs = Rrf + b(Rm - Rrf)
Rs = 5.5% + 1.35(11.5% - 5.5%)
Rs = 13.6%......(answer)