Hefler Healthcare, a pharmaceutical firm, is considering investing in a new business - cosmetics. Hefler has 500 million shares outstanding trading at $ 25 per share; its stock has a beta of 2.50. The firm has $ 6 billion in interest bearing debt outstanding (in market and book value terms), and has operating lease commitments of $ 300 million each year for the next 5 years. The long term treasury bond rate is 4% and the market risk premium is 6%. The unlevered beta for other cosmetics firms is 1.8. If the pre-tax cost of borrowing for Hefler is 8%, estimate the cost of capital that you would use to analyze this project. (The tax rate is 40%) a. 21.21% b. 18.18% c. 14.44% d. 13.51%
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Hefler Healthcare, a pharmaceutical firm, is considering investing in a new business - cosmetics. Hefler has 500 million shares outstanding trading at $ 25 per share; its stock has a beta of 2.50. The firm has $ 6 billion in interest bearing debt outstanding (in market and book value terms), and has operating lease commitments of $ 300 million each year for the next 5 years. The long term treasury bond rate is 4% and the market risk premium is 6%. The unlevered beta for other cosmetics firms is 1.8. If the pre-tax cost of borrowing for Hefler is 8%, estimate the cost of capital that you would use to analyze this project. (The tax rate is 40%)
a.
21.21%
b.
18.18%
c.
14.44%
d.
13.51%
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