EXAMPLE I1.7 Determining the Cost of Equity EXAMPLE I1.8 Determining the Cost of Debt Capstone Corporation needs to raise $55 million for the MicroCHP project de- scribed in Example 11.1. Capstone's target capital structure calls for a debt ratio of 0.4, indicating that $33 million has to be financed from equity. The pertinent information is as follows: For the case in Example 11.7, suppose that Capstone decided to finance the remain- ing $22 million by securing a term loan and issuing 20-year $1,000 par bonds under the following conditions: Capstone is planning to raise $33 million from the financial markets. • Capstone's beta is known to be 2.0, which is higher than 1, indicating that the firm is perceived to be riskier than the market average. • The risk-free interest rate is 5.47%, and the average market return is 13%. (These interest rates are adjusted to reflect inflation in the economy.) • The MicroCHP project is a normal risky project comparable to the firm's mar- Capstone's marginal tax rate is 40%, which is expected to remain constant in the Interest Source Amount Fraction Rate Term loan $6.6 million 0.30 12.16% per year Bonds $15.4 million 0.70 10.74% per year ket risk. future. Determine the after-tax cost of debt. Determine the cost of equity to finance the plant modernization.
Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
Reconsider Examples 11.7 and 11.8. The marginal income-tax rate (tm) for Capstone is expected to remain at 40% in the future. Assuming that Capstone's capital structure (debt ratio) also remains unchanged in the future, determine the cost of capital (k) of raising $55 million in addition to Capstone's existing capital.
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