Key facts and assumptions concerning Costco Company, at December 31, 2011, appea
ID: 2757255 • Letter: K
Question
Key facts and assumptions concerning Costco Company, at December 31, 2011, appear below:
Yield to maturity on long-term government bonds: 3.28%
Yield to maturity on company long-term bonds: 4.62%
Coupon rate on company long-term bonds: 5.50%
Market price of risk, or risk premium: 6.10%
Estimated company equity beta: 0.80
Stock price per share: $75.08
Number of shares outstanding: 449.5 million
Book value of equity: $11,585 million
Book value of interest-bearing debt: $2,524 million
Tax rate: 35%
Use the above information to answer the following questions.
1. Estimate Costco's cost of equity capital.
2. Estimate Costco's weighted-average cost of capital.
Please provide calculation details
Explanation / Answer
1. Costco's Cost of equity capital can be calculated with the help of CAPM method. The formula to calculate the cost of equity is as follows ;
Cost of equity (Ke) = Rf + B(Rm-Rf) ; where Rf = risk free rate ie. 3.28%; B = Beta of company i.e 0.80; Risk Premium (i.e Rm - Rf) = 6.10%. Substituting these values in the formula, we get
Ke. = 3.28 + 0.80(6.10) = 3.28% + 4.88% = 8.16%. Hence, cost of equity is 8.16%
Note: Risk free rate is to be taken as interest on government bonds i.e 3.28%
2. CALCUATION OF WEIGHTED AVERAGE COST OF CAPITAL (iN MILLION DOLLERS)
____________________________________________________________________________________________
SOURCE BOOK VALUE PROPORTION COST (AFTER TAX) WACC
EQUITY $11,585 82% = 8.16% 82% X 8.16% = 6.69
DEBT 2,524 18% 5.50 X 65% = 3.575% 18% X 3.575% = 0,64
Note; Cost of debt is to be taken taken as company's coupon rate of interest after tax ie. 5.50 (100-tax rate i.e 35%) = 3.575%
Cost of equity is taken that is calculted in question no. 1, i.e 8.16%
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