1) ABC Enterprises is presently involved in its annual review of firm's cost of capital. Historically, firm has relied on CAPM to evaluate its cost of equity capital. Firm evaluates that its equity beta is= 1.25 and present yield on long-term U.S. Treasury bonds is= 4.28%. Firm's CFO is presently in the debate with one of firm's advisors at its investment bank about level of equity risk premium. Historically, ABC has used 7% to estimated equity risk premium. Though, investment banker argues that this premium has reduced in size dramatically in current years and is more probable to be in the 3% to 4% range.
a) Evaluate ABC cost of equity capital by using the market risk premium of 3.5%.
b) ABC capital structure is comprised o= 75% equity (based on present market prices) and 25% debt on which firm pays the yield of 5.125% before taxes at 25%.
c) What is firm's WACC under each of 2 suppositions about market risk premium?