Question

5. Below you are given information on Efaw, Inc.’s capital structure as well as information on Efaw’s stock and bonds. Compute Efaw’s cost of capital.

Capital Structure
Book Value of Debt	$2,000,000,000
Market Value of Debt	$2,500,000,000
Book Value of Equity	$3,500,000,000
Market Value of Equity	$4,000,000,000
Stock Info
Beta	1.32
Risk free rate	1.25%
Market risk premium	7.50%
Cost of issuing equity	5%

Bond Info
Coupon rate	6%
Years to mat;urity	22
Par value	$1,000
Price of bond	$963.75
Cost of issuing debt	2.50%

Answer 1

Cost of equity :-

Cost of equity = Rf + Beta * (Rm - Rf)

= 1.25% + 1.32 * (7.5% - 1.25%)

Cost of equity = 9.5%

Cost of debt =[ I+ ( F - NP)/n] /[( F+NP)/2]

I = 1000 *6% = 60

F = 1000

NP = price - flotation cost = 963.75 - 1000*2.5% = $ 938.75

n = 22 year

Cost of debt = [60 + ( 1000 -938.75) / 22 ] / [ ( 1000+938.75) /2]

= 62.7841 / 969.375

Cost of debt = 6.4768%

Weighted average cost of capital based on market value :-

Particulars	market value	weight	cost	component
Debt	2,500,000,000	0.3846	6.4768%	2.491%
Equity	4,000,000,000	0.6154	9.5%	5.8463%
	WACC based on market value	8.3373%

Weighted average cost of capital based on book values :-

Particulars	book value	weight	cost	component
Debt	2,000,000,000	0.3636	6.4768%	2.355%
Equity	3,500,000,000	0.6364	9.5%	6.0458%
	WACC based on book value	8.4008%