Question

Calculate the cost of capital for operations (WACC) for Surfer, Inc. Use the capital asset pricing...

Calculate the cost of capital for operations (WACC) for Surfer, Inc. Use the capital asset pricing model to estimate the cost of equity capital.

      U.S. Government long-term bond rate                             2.75%

      Market risk premium                                                         5.50%

      Equity beta                                                                       1.30

      Per-share market price                                                 $35.00

      Shares outstanding                                                      100.0 million

      Net financial obligations on balance sheet                 $700.0 million

      Weighted-average borrowing cost                                    6.0%

      Statutory tax rate                                                            25.0%

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Answer #1

Answer:

Cost of Equity:

Risk free rate = US Government long-term bond rate = 2.75%

Market risk premium = 5.50%

Equity beta = 1.30

Cost of equity = Required return = Risk free rate + Beta * Market risk premium = 2.75% + 1.30 * 5.50% = 9.90%

Cost of debt:

Before tax cost of debt = 6.0%

Capital structure:

Market value of equity = Per-share market price * Shares outstanding = $35.00 * 100.0 million = $3500.0 million

Debt = $700.0 million

Proportion of market equity = 3500 / (3500 + 700) = 5/6

Proportion of debt = 700 / (3500 + 700) = 1/6

WACC

WACC = Cost of equity * Equity proportion + before tax cost of debt * (1 - Tax rate) * debt proportion

= 9.90% * 5/6 + 6% * (1 - 25%) * 1/6

= 9.00%

Cost of capital for operations (WACC) for Surfer, Inc. = 9%

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