ABC Insurance Company is financed by $500 million of equity and $500 million of
ID: 2671414 • Letter: A
Question
ABC Insurance Company is financed by $500 million of equity and $500 million of debt. (The debt is througha holding company; this makes no difference for the financial analysis.)
The yield to maturity on ABC’s debt equals its coupon rate of 8% per annum. The risk-free rate is 5% per
annum, the market risk premium is 7%, and ABC has a CAPM beta of 1.000. The corporate tax rate is 35%.
In 20X1, ABC paid $40 million in interest and earned $75 million in accounting income.
A. What is ABC’s after-tax debt payment?
Explanation / Answer
I think your question is after tax cost of capital For equity cost of capital = risk free rate + beta (market risk premium) = 5 + 1(7) = 12% Cost of debt = 8 (1-0.35) = 5.2% Since both are equally weighted, then the cost of capital would be = (12+5.2) /2 = 8.6% Answer