You have been given the following facts and assumptions concerning ABC Corp\'s a

Question

You have been given the following facts and assumptions concerning ABC Corp's 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 S40 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 the appropriate weight of debt to be used when calculating ABC Corp's weighted average cost of capital?

Explanation / Answer

Weighted average cost of capital = 0.08545 or 8.55%

Specific cost of equity = Risk-free rate + Beta x Market risk premium = 5% + 1.5 ( 8% -5%) = 9.5% or 0.095

Specific cost of debt = After-tax coupon rate = 0.07 x ( 1-0.35) = 0.0455

Source of capital Book values Book value weights Specific costs Weighted costs Equity $ 5,240 million 0.807 0.095 0.07667 Debt $ 1,250 million 0.193 0.0455 0.00878 Total $ 6,490 million 1.000 0.08545

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