Question
In: Finance
Electric Youth, Inc. (EY) is a publicly-traded firm that is the market share leader in perfume...
Electric Youth, Inc. (EY) is a publicly-traded firm that is the market share leader in perfume for teenagers. You are charged with estimating the cost of capital for the firm. The following market data on EY’s securities are current:
|
Debt |
10,000 seven percent coupon bonds outstanding, 15 years to maturity, selling for 92 percent of par; the bonds have a $1,000 par value each and make annual payments. |
|
Common stock |
250,000 shares outstanding, selling for $55 per share; the beta is 1.4. |
|
Market |
7 percent expected market risk premium; 5 percent risk-free rate. |
EY’s tax rate is 22 percent.
To do: estimate EY’s cost of capital. Show all work.
Solutions
Expert Solution
Calcuate cost of Debt and Cost of Equity
COst of Debt = Intrest payment (1-Tax)/Total debt
Cost of debt = ((10000*1000)*7%)*(1-0.22)/10000*1000 = 5.46%
Cost of Equity = Risk free rate + (beta * Market premium)
COst of equity = 5+(1.4*7) = 14.8
WACC = Cost of equity * Market value of Equity/(Market value of equity+Market value of Debt) + Cost of debt * Market value of debt/(Market value of equity+Market value of Debt)
Market value of Debt = 10000*920 = 9200000
MArket value of Equity = 250000*55 = 13750000
WACC = 14.8*13750000/(9200000+13750000) + 5.46*9200000/(9200000+13750000) = 12.138%
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