a) What is the best estimate of the after-tax cost of debt?
b) Based on the CAPM, what is the firm’s cost of equity?
c) What is the best estimate for the weight of debt to use in calculating the firm’s WACC?
Exhibit 1
Assume that you have been hired as a consultant by Igglepiggle, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm’s weighted average cost of capital. The balance sheet and some other information are provided below.
Assets
Current assets $ 38,000,000
Net plant, property, and equipment 101,000,000
Total assets $139,000,000
Liabilities and Equity
Accounts payable $ 10,000,000
Accruals 9,000,000
Current liabilities $ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value) 40,000,000
Total liabilities $ 59,000,000
Common stock (10,000,000 shares) 30,000,000
Retained earnings 50,000,000
Total shareholders' equity 80,000,000
Total liabilities and shareholders' equity $139,000,000
The stock is currently selling for $15 per share and its non-callable $1,000 par value, 20-years until maturity, 7% coupon bonds with semi-annual payments are selling for $900. The stock’s beta is 1.5 and the risk-free rate is 3%. The required return on the stock market is 9%. The firm's marginal tax rate is 40%.