You are given the following information on Norne Corporation: Debt 9000 corporat

Question

You are given the following information on Norne Corporation:

Debt 9000 corporate bonds with $1000 par value and a current price of $1040.the bonds have a 6.2% coupon, pay interest semiannually. and mature in 20 years

Equity 225000 shares of common stock selling at $64.5 per share, the stock has a beta of 0.85

Market The expected return on the market is 12% , and the risk free rate is 5% If the tax rate for norne is 35%

A) Calculate the after-tax cost of debt for Norne

B) Calculate the cost of equity for Norne

C) Calculate the weighted average cost of capital for Norne.

Explanation / Answer

A) After-tax cost of debt for Norne = Interest *(1- tax rate)

= 6.2 * (1- .35)

= 4.03

B) Cost of equity for Norne = risk free return + Beta * (market return - risk free return)

= 5 + 0.85*(12-5)

= 10.95

Bonds = 9000 * 1040 = 9,360,000

Common stock = 225000 * 64.5 = 14,512,500

Total capital structure = 23872500

Weight of bond/debt = 9360000/23872500 = 0.39

Weight of equity =14,512,500/ 23872500 = 0.61

C) Weighted average cost of capital for Norne.

= Cost of equity * weight of equity + Cost of debt * weight of debt

= 10.95 * (.61) + 4.03 * (.39)

=8.25%

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