AAA has only stock and bonds in its capital structure. Balance sheet information
ID: 2677580 • 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) = $1,100.00, bond annual coupon rate with semiannual payments = 7.0%, 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 for the required return on the stock, find the company's weighted average cost of capital.Explanation / Answer
The term capital structure refers to the percentage of capital (money) at work in a business by type. Broadly speaking, there are two forms of capital: equity capital and debt capital. Each has its own benefits and drawbacks and a substantial part of wise corporate stewardship and management is attempting to find the perfect capital structure in terms of risk / reward payoff for shareholders. This is true for Fortune 500 companies and for small business owners trying to determine how much of their startup money should come from a bank loan without endangering the business.