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Question - You have been asked to estimate the cost of capital for Lemur Enterprises, a company with a significant debt load, and a depressed stock price. You have the following information:
The company has a book value of equity of $1 billion. There are 150 million shares, trading at $4/share. The unlevered beta of other companies in the same business is 1.20.
The company has bank loans outstanding of $1 billion, with 5 years left to maturity and interest expenses of $40 million a year. The company currently has a CCC bond rating and has a default spread of 7% over the risk-free rate.
The firm reported a net loss of -$15 million, but its operating income is expected to be $32 million next year.
The risk-free rate is 3%, the equity risk premium is 5% and the marginal tax rate for all companies is 25%.
Required - Estimate the cost of capital for the company, for next year?
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