Calculate the… A. Cost of debt B. Cost of equity with the Capital Asset Pricing

Question

Calculate the…

A. Cost of debt                 

B. Cost of equity with the Capital Asset Pricing Model (CAPM)

C. Cost of equity with the Dividend Growth Model (DGM)DGM

D. WACC with book value                            

MARKET DATA:              

U.S. Treasury rate:                 3.5%

Stock market total return:     12.1%

Inflation                             3.0%

COMPANY DATA:                          

Dividend growth rate:                          4.6%

Outstanding bond YTM:                        4.0%

Next year’s expected dividend:          $1.50

Tax rate:                     40%

Shares outstanding:                               100,000

Beta:                           1.05

Stock price                        $19.50

Debt / capital ratio:                               25%

Explanation / Answer

Cost of debt After tax cost of debt = (Before tax cost of debt) x (1 – Marginal tax rate) =4 (1-.40) 2.4 The CAPM formula is: ra = rrf + Ba (rm-rrf) where: rrf = the rate of return for a risk-free security rm = the broad market's expected rate of return Ba = beta of the asset =3.5%+1.05(12.1%-3.5%) =3.5%+9.03% 12.53% dividend growth model: Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate =(1.5/19.5)+4.6 4.68 weighted average cost type of capital Amount cost after tax weight WACC equity 100000 4.68 0.8 3.744 debit 25000 2.4 0.2 0.48 125000 1 4.224 debit /equity ratio 25% so debt 25000

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