Question

Current assets	$38,000,000	Accounts Payable	$10,000,000
		Accruals	$9,000,000
Net plant, property & equipment	$101,000,000	Current Liabilities	$19,000,000
		Long term debt (40,000 bonds, $1,000 face value)	$40,000,000
		Common Stock (10,000,000 shares)	$30,000,000
		Retained Earnings	$50,000,000
		Total shareholders equity	$80,000,000
Total Assets	$139,000,000	Total Liabilities and shareholders Equity	$139,000,000

Your boss has asked you to estimate the weighted average cost of capital for CGT company. You have the above balance sheet and this information:

CGT stock is currently selling for $7.50 per share and CGT bonds are selling for $889.50 per bond. These bonds have a 7.25 percent annual coupon rate, with semi-annual payments. The bonds mature in twenty years. The beta for CGT is approximately equal to 1.1. The yield on a 6-month treasury bill is 3.5% and the yiel on a 20 year treasury bond is 5.5%. The expected return on the stock market is 11.5%, but the stock market has had an average annual return of 14.5% during the past five years. CGT is in the 40% tax bracket.

Using the CAPM approach, what is the best estimate of the cost of equity for CGT? What is the best estimate for the after-tax cost of debt for CGT? What is the best estimate for the weights to be used when calculating the WACC?

Answer 1

		weight %	Cost
Long term debt (40,000 bonds, $1,000 face value)	40000000.00	33%	0.051892	0.017297
Common Stock (10,000,000 shares)	30000000.00	25%	0.154	0.0385
Retained Earnings	50000000.00	42%	0.154	0.064167
WACC				0.119964	12.00%
Cost Of Debt	(Copuon Payment net of Tax + (Redemption value- Net Proceeds)/No of year to redemption)/ (Net Proceeds+Redemption value/2)
	0.051892035
Cost Of Share	Risk Free Rate+ Beta(Market rate-risk free rate)
	0.154