Chapter 8 Problem 20 Key facts and assumptions concerning Kroger Company, at Dec

Question

Chapter 8 Problem 20 Key facts and assumptions concerning Kroger Company, at December 12, 2007, appear below. Using this information, answer the questions following. Facts and Assumptions Yield to maturity on long-term government bonds 4.54% Yield to maturity on company long-term bonds 6.32% Coupon rate on company long-term bonds 7.50% Market price of risk, or risk premium 6.30% Estimated company equity beta                1.05 Stock price per share $          25.97 Number of shares outstanding              681.2 million Book value of equity $           4,965 million Book value of interest-bearing debt $           6,674 million Tax rate 35.0% a. Estimate Kroger's cost of equity capital. b. Estimate Kroger's weighted-average cost of capital. Prepare a spreadsheet or table showing the relevant variables. Chapter 8 Problem 20 Key facts and assumptions concerning Kroger Company, at December 12, 2007, appear below. Using this information, answer the questions following. Facts and Assumptions Yield to maturity on long-term government bonds 4.54% Yield to maturity on company long-term bonds 6.32% Coupon rate on company long-term bonds 7.50% Market price of risk, or risk premium 6.30% Estimated company equity beta                1.05 Stock price per share $          25.97 Number of shares outstanding              681.2 million Book value of equity $           4,965 million Book value of interest-bearing debt $           6,674 million Tax rate 35.0% a. Estimate Kroger's cost of equity capital. b. Estimate Kroger's weighted-average cost of capital. Prepare a spreadsheet or table showing the relevant variables.

Explanation / Answer

Expected return = Rf+×Rp

Rf is risk free return

Rp is risk premium

WACC = Wd×Rd×(1-t)+ We×Ke

W is weights of respective portfolios

R is return on respective portfolios

a)

Cost of equity:

= 4.54%+1.05×6.3%

= 11.16%

b)

WACC = [$6,674÷($4,965+$6,674)]×6.32%×(1-35%)+[$4,965÷($4,965+$6,674)]×11.16%

= 7.12%

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