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You have been asked to estimate the cost of capital for the UTX corporation. The company has 7 million shares and 150,000 bonds outstanding at par value $10,000. In addition, it has $300 million in short-term debt from its bank. The target capital structure ratio is 60 percent equity, 30 percent long-term debt, and 10 percent short-term debt. The current capital structure has temporarily moved slightly away from the target ratio. The company's shares currently trade at $60 with a beta of 1.50. The book value of the shares is $20. The annual coupon rate of the bonds is 10 percent, they trade at 110 percent of par, and they will mature in seven years. Interest on the short-term debt is 8 percent. The current yield on ten-year government bonds is 6.5 percent. The market risk premium is 5 percent. The corporate tax rate applicable is expected to be 30 percent. Based on these data, calculate the cost of capital for the UTX Corporation.
Suppose you initially have $100 in stock and $35 in T-bills creating a portfolio with total assets of $135. Suppose the stock market index initially at time 0.
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