Question

Q6

3.What would be the component cost of debt estimated from a ten year bond bond with face value of $1,000 and selling for $1,000 with annual coupons of 14% paid annually and with a tax rate of 36%? Answer as a percentage to the nearest hundredth as in xx.xx and without the percentage sign.

4.Suppose the risk free rate is 5.3% and the expected rate of return to the market is 10.6%. If the stock's beta is 0.6, what is the estimated cost of equity based on the CAPM technique? Answer to the nearest hundredth of a percent as in xx.xx and enter without the percent sign.

Answer 1

Question 3

Now, since the current market value of bond = par value of bond, the yield to maturity (or pretax cost of debt) for the bond would be equal to coupon rate.

Hence, pretax cost of debt = 14%

Post tax cost of debt = pretax cost of debt * (1 - Tax rate)

Post tax cost of debt = 14% * (1 - 36%) = 8.96%

Question 4

Based on CAPM,

Cost of equity = Risk free rate + Beta * (Expected market return - Risk free rate)

Cost of equity = 5.3% + 0.6 * (10.6% - 5.3%)

Cost of equity = 5.3% + 3.18% = 8.48%