AAA has only stock and bonds in its capital structure. Balance sheet information
ID: 2677567 • Letter: A
Question
AAA has only stock and bonds in its capital structure. Balance sheet information: Long term debt (par value--NOT number of bonds) = $20,000,000, Common equity and retained earings = $17,000,000, and Shares of stock outstanding = 1,000,000. Bond information: Bond price ($1,000 par value per bond) = $1,150.00, bond annual coupon rate with semiannual payments = 6.0%, and bond maturity = 10 years. Stock information: Stock price = $40.00, beta = 1.25, recent dividend (D0) = $3.00, dividend growth rate = 4.00%. Other information: risk free rate = 4.0%, the market risk premium = 6.5%, tax rate = 40.0%. Using the average of the CAPM and DCF estimates, find the required return on equity.Explanation / Answer
CAPM 4.0 +1.25* 6.5= 12.125%
DCF 40= 3.00*1.04/(r-.04)= 11.8%
Average of two 11.9625% cost of equity.