The company you work for wants you to estimate the company\'s WACC; but before y
ID: 2658116 • Letter: T
Question
The company you work for wants you to estimate the company's WACC; but before you do so you need to estimate the cost of debt & equity. you have obtained the following information 1. the firms non callable bonds mature in 20 years have an 7% annual coupon, a par value $1,000 and market price of $1,255 2. Company was rate is 35% 3. the risk free rate is 4.5% 4. market risk premium is 5.5% 5. stocks beta is 1.2 6. the target capital structure consists of 45% debt and a balance of common equity. the firm uses CAPM to estimate the cost of equity and does not except to issue and new common stock. Calculate the company's component cost of debt. please show work
Explanation / Answer
I am assuming you only need the calculation for cost of debt since thats what is mentioned in the question. If you are looking for the calculation of WACC also, please put it in the comments.
Coupon payment = 0.07 * 1000 = 70
price = 1,255
Face value = 1000
Years to maturity = 20
Before tax cost of debt using a financial calculator = 4.9606%
Keys to use in a financial calculator: PV -1255, FV 1000, N 20, PMT 70, CPT I/Y
After tax cost of debt = 0.049606 ( 1 - 0.35)
After tax cost of debt = 0.03224 or 3.224%
Component cost of debt is 3.224%
Cost of retained of retained earnings using CAPM = risk free rate + beta ( amrket risk premium)
Cost of retained of retained earnings = 0.045 + 1.2 ( 0.055)
Cost of retained of retained earnings = 0.111 or 11.1%