The following question requires the determination of a firm's decision to use its cost of capital structure to make various investment decisions for the firm and its shareholders.
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Robinson-Winston, Inc. (RWI) has asked you to estimate the cost of capital for the firm. The company has 4 million shares and 125,000 bonds of par value $1,000 outstanding. In addition, it has $20 million in short-term debt from its bank. The target capital structure ratio is 55 percent equity, 40 percent long-term debt, and 5 percent short-term debt. The current capital structure has temporarily moved slightly away from the target ratio.
The company’s shares currently trade at $50 with a beta of 1.03. The book value of the shares is $16. The annual coupon rate of the bonds is 9 percent; they trade at 108 percent of par, and they will mature in ten years. Interest on the short-term debt is 3.5 percent. The current yield on ten-year government bonds is 5.2 percent. The market risk premium is 5 percent. The company tax rate applicable is expected to be 35 percent.
Based on the data above, calculate the cost of capital for the company.