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Lister Inc. is a small, publicly traded data processing company that has $200 million in debt...

  1. Lister Inc. is a small, publicly traded data processing company that has $200 million in debt outstanding, in both book value and market value terms. The book value of equity in the company is $400 million and there are 40 million shares outstanding, trading at $20/share. The current levered beta for the company is 1.15 and the company’s pre-tax cost of borrowing is 5%. The current risk-free rate in US $ is 3%, the equity risk premium is 5% and the marginal tax rate is 40%.

  1. Estimate the current cost of capital for the company.
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Answer #1
Formula to calculate WACC
WACC Wd*Kd*(1-tax rate) + We*Ke
Wd is weight of debt, Kd is cost of debt, We is weight of equity, Ke is cost of equity
Calculation of firm's market value weight
Debt $200.00
Equity $800.00 (40*20)
Total value $1,000.00
Weight of debt 200/1000
Weight of debt 20.00%
Weight of equity 800/1000
Weight of equity 80.00%
Using CAPM model we would calculate cost of equity
Cost of equity Risk free rate + Beta*Market risk premium
Cost of equity 0.03+(1.15*0.05)
Cost of equity 0.03+0.0575
Cost of equity 8.75%
WACC (0.05)*(1-0.40)*0.20+(0.0875*0.80)
WACC 7.60%
Thus, current cost of capital for company is 7.60%
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