You have been asked to calculate the cost of capital for a company with the foll

Question

You have been asked to calculate the cost of capital for a company with the
following information. The company has $7,500,000 in face value bonds, trading at 96.5% of face value.The YTM on these bonds is 5.75%. There are also 1,000,000 shares outstanding with a book value of$4.50 per share and a market value of $9.50 per share. The equity beta is 1.75, the expected return on themarket is 9%, and the risk-free rate is 2%. Given this information, what is the estimated cost of capital?There are no taxes.

Explanation / Answer

COST OF DEBT = > INTEREST EXPENSE / AMOUNT OF DEBT

=> (7500000 * 96.5% * 5.75%)/ 7237500

=> 416156.25/ 7237500

COST OF DEBT => 5.75%

CSOT OF EQUITY BY USING CAPM MODEL

CAPM = Risk-Free Return + (Beta x (Average Stock Return – Risk-Free Return))

=> 2% + (1.75 * (9-2)%

CAPM=> 14.25%

SO, ESTIMATED COST OF CAPITAL => 5.75% + 14.25% =>20%

COST OF CAPITAL => 20%

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