Reference no: EM131538272

a) What is the best estimate of the after-tax cost of debt?

b) Based on the CAPM, what is the firm’s cost of equity?

c) What is the best estimate for the weight of debt to use in calculating the firm’s WACC?

Exhibit 1

Assume that you have been hired as a consultant by Igglepiggle, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm’s weighted average cost of capital. The balance sheet and some other information are provided below.

Assets

Current assets $ 38,000,000

Net plant, property, and equipment 101,000,000

Total assets $139,000,000

Liabilities and Equity

Accounts payable $ 10,000,000

Accruals 9,000,000

Current liabilities $ 19,000,000

Long-term debt (40,000 bonds, $1,000 par value) 40,000,000

Total liabilities $ 59,000,000

Common stock (10,000,000 shares) 30,000,000

Retained earnings 50,000,000

Total shareholders' equity 80,000,000

Total liabilities and shareholders' equity $139,000,000

The stock is currently selling for $15 per share and its non-callable $1,000 par value, 20-years until maturity, 7% coupon bonds with semi-annual payments are selling for $900. The stock’s beta is 1.5 and the risk-free rate is 3%. The required return on the stock market is 9%. The firm's marginal tax rate is 40%.