Assignment
Assume your boss has asked you to re-estimate the company's cost of capital for capital budgeting purposes based on up-to-date information.
If the re-estimated cost of capital is different to that used previously, he would also like a brief qualitative assessment (no calculations necessary) of the impact of the difference on (a) the project analyses you previously undertook for him and (b) the value of the firm. Also discuss briefly the appropriateness of your re-estimated cost of capital as a discount rate for the projects.
ABC currently has 8,000 bonds outstanding paying a coupon of 7.5% p.a. The bonds have a $1,000 par value and the coupon payments are semi-annual. The bonds are currently selling for 92% of par and have 20 years to maturity. The company has 600,000 ordinary shares outstanding, currently selling for $57 per share, and 40,000 9% preference shares outstanding with a par value of $100, currently selling for $93 per share. The company also has a bank loan of $4 million with an interest rate of 7%. ABC has a tax rate of 30% and a beta of 1.5. It is expected that the company's current capital structure will remain the same. Treasury bonds are yielding 3% but some firms have bonds on issue yielding as much as 15%. The market risk premium is expected to be 7%.
Ensure you present your analysis in such a way that your boss will be able to easily follow what you have done and any assumptions you have made.