1. ABC Incorporated shares are currently trading for $30 per share. The firm has 1.4 billion shares outstanding. In addition, the market value of the firm's outstanding debt is $2.3 billion. The 10-year Treasury bond rate is 6.45%. ABC has an outstanding credit record and has earned an AAA rating from the major credit rating agencies. The current interest rate on AAA corporate bonds is 6.75%. The historical risk premium for stocks over the risk-free rate of return is 5.2 percentage points. The firm's beta is estimated to be 1.2 and its marginal tax rate, including federal, state, and local taxes is 40%.
a. What is the cost of equity?
b. What is the after-tax cost of debt?
c. What is the cost of capital?
2. The following information is available for two different common stocks: company A and Company B
Company A Company B
Free cash flow per share in the current year
$1.30 $6.00
Growth rate in cash flow per share 10% 3%
Beta 1.5 .7
Risk-free return 6.5% 6.5%
Expected return on all stocks 14.5% 14.5%
a. Estimate the cost of equity for each firm.
b. Assume that the companies' growth rates will continue at the same rate indefinitely. Estimate the per share value of each companies common stock.