You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns: Year 2007 2008 Risk-free Return 3% 1% Market Return 6% -37% XYZ Return 10% -45% a. What was XYZ's average historical return? b. Compute the market's and XYZ's excess returns for each year. Estimate XYZ's beta. c. Suppose the current risk-free rate is 3%, and you expect the market's return to be 8%. Use the CAPM to estimate an expected return for XYZ Corp.'s stock. d. Would you base your estimate of XYZ's equity cost of capital on your answer in part (a) or in part (c)?
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.
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