I need help in answering the following questions. Under what situations would yo

Question

I need help in answering the following questions.

Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The constant-growth model?

Cost of Equity JaiLai Cos. stock has a beta of 1.2, the current risk-free rate is 4.2 percent, and the expected return on the market is 12 percent. What is JaiLai’s cost of equity?

Cost of Debt KatyDid Clothes has a $250 million (face value) 30-year bond issue selling for 103 percent of par that carries a coupon rate of 7.95 percent, paid semiannually. What would be Katydid’s before-tax component cost of debt?

Cost of Preferred Stock Marme, Inc. has preferred stock selling for 97.5 percent of par that pays an 8 percent annual coupon. What would be Marme’s component cost of preferred?

WACC Suppose that JB Cos. has a capital structure of 75 percent equity, 25 percent debt, and that its before-tax cost of debt is 9 percent while its cost of equity is 15 percent. If the appropriate weighted average tax rate is 30 percent, what will be JB’s WACC?

Payback Compute the payback statistic for Project with the following cash flows:

Time             0             1             2             3             4

Cash flow -150,000     60000   60000   70000   100000

Deciding whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 8 percent and the maximum allowable payback is three years.

Discounted Payback Compute the discounted payback statistic for Project in the above example and recommend whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years.

IRR Compute the IRR statistic for project in problem 1and note whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 7.5 percent.

PI Compute the PI statistic for Project in problem 1 and advise the firm whether to accept or reject the project if the appropriate cost of capital is 8 percent.

Explanation / Answer

JaiLai Cos. cost of equity (CAPM) = Rf+×Rp

Rf is risk free return

is beta of the security

Rp is risk premium

= 4.20%+1.20×(12%-4.20%)

= 13.56%

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