Fran McClure of Alba Advisers is estimating the cost of capital of Frontier Corp

Question

Fran McClure of Alba Advisers is estimating the cost of capital of Frontier Corporation as part of her valuation analysis of Frontier. McClure will be using this estimate, along with projected cash ows from Frontier’s new projects, to estimate the effect of these new projects on the value of Frontier. McClure has gathered the following information on Frontier Corporation:

Current Year Forecasted for Next Year

Book value of debt $50 $50Market value of debt $62 $63

Book value of shareholders’ equity $55 $58

Market value of shareholders’ equity $210 $220

The weights that McClure should apply in estimating Frontier’s cost of capital for debt and equity are, respectively:

wd=0.200; we=0.800.

wd=0.185; we=0.815.

wd=0.223; we=0.777.

wd=0.200; we=0.800.

wd=0.185; we=0.815.

wd=0.223; we=0.777.

Explanation / Answer

wd = 0.223 & we=0.777

Market Value of Debt 63 Market Value of Equity 220 Weight of Debt = Market Value of Debt / (Market Value of Debt + Market Value of Equity) =63/(63+220) = 0.223 Weight of Equity = Market Value of Equity / (Market Value of Debt + Market Value of Equity) =220/(63+220) = 0.777

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