Attached you will find some information of ABC Inc. at December 31, 2012. Yield

Question

Attached you will find some information of ABC Inc. at December 31, 2012. Yield to maturity on long-term bonds 4.4% Yield to maturity on company long-term bonds 6.3% Coupon rate on company long-term bonds 7.0% Market price of risk, or excess return 6.5% Estimated company equity beta           1.20 Stock price per share $          40 Number of shares outstanding            240 million Book value of equity $       5.24 million Book value of interest-bearing debt $       1.25 million Tax rate 35.0% 1. Estimate FM's after-tax cost of equity capital. (1 point) 2. Estimate FM's after-tax cost of debt capital. (1 point) Attached you will find some information of ABC Inc. at December 31, 2012. Yield to maturity on long-term bonds 4.4% Yield to maturity on company long-term bonds 6.3% Coupon rate on company long-term bonds 7.0% Market price of risk, or excess return 6.5% Estimated company equity beta           1.20 Stock price per share $          40 Number of shares outstanding            240 million Book value of equity $       5.24 million Book value of interest-bearing debt $       1.25 million Tax rate 35.0% 1. Estimate FM's after-tax cost of equity capital. (1 point) 2. Estimate FM's after-tax cost of debt capital. (1 point)

Explanation / Answer

1. After tax cost of equity capital.

We can compute the value of equity capital by using the capm model

Ke = Rf + b(Rm-Rf)

Rf = YTM on long term bonds(considerng them to be government risk free bonds) = 4.4%

b = 1.2

RM-Rf = Market price of risk(excess return) = 6.5%

Ke = 4.4 + 1.2(6.5)

Ke = 12.2%

Cost of equity = 12.2%

2) After tax cost of debt

Kd = I (1-t)

I = YTM on company long term bond = 6.3%

t = 35%

Kd = 6.3 (1-0.35)

Kd = 4.095%

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