You have been given the following facts and assumptions concerning ABC Corp. at

Question

You have been given the following facts and assumptions concerning ABC Corp. at December 31, 2013. Yield to maturity on long term government bond is 5.00%. Yield to maturity on company long term government bond is 7.0%.Coupon rate on company long term bond is 7.0%.Market price of risk is 8.0% along with estimated company beta value of 1.5.Stock is selling for $40 in the market and 250 million shares are outstanding. Assuming that book value of equity is $5240 million along with book value of interest bearing debt of $1250 million. Existing tax rate stands at 35%.Given all the information estimate ABC Corp's after-tax cost of equity capital?

Explanation / Answer

Risk free rate = Yield to maturity of long term government bonds = 5%

Beta = 1.5

Market risk premium = Market price of risk = 8%

As per CAPM,

Cost of equity = Expected return on equity = Risk free rate + Beta*Market risk premium = 5% + (1.5*8%) = 5%+12% = 17%

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