Find the cost of common equity using the CAPM method

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Reference no: EM132040366

BearKat wants to build a new assembly line to improve productivity. It is expected to generate a return of 17%. Sammy wants to know what he should use for his hurdle rate or WACC (weighted average cost of capital).

Sammy’s accountant provides you the following information.

Common stock is selling for $73 a share. The current annual dividend is $2.36 and the growth rate is expected to be 2% a year. The stock’s beta is 1.77.

Preferred stock sells for $123 and pays an annual dividend of $25.

There are currently 15 year callable, 3% coupon bonds available at a price of $988. The yield to maturity of these bonds is 3.1%.

There are 20 year, non-callable 5% coupon bonds that pay annual payments and are available at a price of $1,080. The yield to maturity of these bonds is 4.39%.

There are 5 year 7% coupon bonds that pay annual payments and are available at a price of $1,234. The yield to maturity of these bonds is 2.03%.

The bond-yield risk premium is 2%.

The current risk free rate is .5% and the market risk premium is 4%.

BearKat Autos has a target capital structure of 40% debt, 5% preferred stock and 55% common equity and their current tax rate is 25%.

1. What is the BearKat Autos’ after tax cost of debt (rounded to two decimal places)?

A. 2.33%

B. 1.52%

C. 3.29%

D. 4.39%

E. 2.03%

2. What is the BearKat Autos’ cost of preferred stock (rounded to two decimal places)?

A. 20.33%

B. 4.92%

C. 15.75%

D. 10%

3. Do we need to adjust the cost of preferred stock for taxes?

A. Yes, because the preferred dividends are tax deductible

B. No,becausethepreferreddividendsarenottaxdeductible.

4. What is BearKat Autos’ cost of common equity using the DCF method?

A. 0.36%

B. 5.23%

C. 3.29%

D. 5.30%

5. What is BearKat Autos’ cost of common equity using the bond-yield plus risk premium method.

A. 8.39%

B. 6.39%

C. 2%

D. 5.1%

6. Find the cost of common equity using the CAPM method.

A. 7.58%

B. 12.08%

C. 0.54%

D. 4.04%

7. What is the (simple) average of the 3 above calculated costs of common equity values. Use this average as the eventual cost of common equity for Bearkat Autos.

A. 4.59%

B. 7.15%

C. 1.395

D. 6.42%

8. What is the WACC for BearKat Autos (rounded to two decimal places, pick the closest one)?

A. 5.87%

B. 6.31%

C. 5.48%

D. 7.89%

Reference no: EM132040366

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