You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastic goods: plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the Vice-President of Finance. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT.
Total Assets $139,000,000
Long term debt (40,000 bonds, $1,000 face value) $ 40,000,000
Total liabilities $ 59,000,000
Common Stock 10,000,000 shares) $ 30,000,000
Retained Earnings $ 50,000,000
Total shareholders equity $ 80,000,000
Total liabilities and shareholders equity $139,000,000
You check The Wall Street Journal and see that CGT stock is currently selling for $7.50 per share and that CGT bonds are selling for $889.50 per bond. These bonds have a 7.25 percent annual coupon rate, with semi-annual payments. The bonds mature in twenty years. The beta for your company is approximately equal to 1.1. The yield on a 6-month Treasury bill is 3.5 percent and the yield on a 20-year Treasury bond is 5.5 percent. The expected return on the stock market is 11.5 percent, but the stock market has had an average annual return of 14.5 percent during the past five years. CGT is in the 40 percent tax bracket.
7. Using the CAPM approach, what is the best estimate of the cost of equity for CGT?
8. What is best estimate for the after-tax cost of debt for CGT?
9. Which of the following is the best estimate for the weights to be used when calculating the WACCC?
10. What is the best estimate of the WACC for CGT?
WACC is calculated after calculating the cost of equity (using CAPM) and the after-tax cost of debt using market value weights. Calculations and solutions are provided in the attached Excel file. All calculations are written out in a step by step manner to make it easy for a student to follow.