Key facts and assumptions concerning Costco Company, at December 31, 2011, appea

Question

Key facts and assumptions concerning Costco Company, at December 31, 2011, appear below: Yield to maturity on long-term government bonds: 3.28% Yield to maturity on company long-term bonds: 4.62% Coupon rate on company long-term bonds: 5.50% Market price of risk, or risk premium: 6.10% Estimated company equity beta: 0.80 Stock price per share: $75.08 Number of shares outstanding: 449.5 million Book value of equity: $11,585 million Book value of interest-bearing debt: $2,524 million Tax rate: 35% Use the above information to answer the following questions. 1. Estimate Costco's cost of equity capital. 2. Estimate Costco's weighted-average cost of capital.

Explanation / Answer

Part 1)

The Costco's cost of equity capital is calculated with the use of following formula:

Cost of Equity Capital = Government Borrowing Rate + Beta*Market Risk Premium

___________

Using the information provided in the question, we get,

Cost of Equity Capital = 3.28% + .80*6.10% = 8.16%

___________

Part 2)

The weighted average cost of capital is calculated with the use of following table:

Costco's Weighed Average Cost of Capital = 7.80%

Instrument Amount (Millions) Weight in Percentage (A) After-Tax Cost (B) Weighted Cost (A*B) Debt 2,524 7% (2,524/36,272.46*100) 3% (4.62%*(1-35%)) 0.21% Equity 33,748.46 (449.5*75.08) 93% (33,748.46/36,272.46*100) 8.16% (calculated above) 7.59% Total 36,272.46 7.80%

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