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Cost of Equity

A firm has $2 million of capital needs. The firm has noticed that the current yield to maturity on its bonds is 9.5%, and its stock beta is 1.2. Currently, the expected return on the S&P 500 stocks is 12%, and the 90-day T-bill rate is 5%. The firm's target capital structure is 40% debt and 60% equity. The firm's marginal tax rate is 28%

What is the cost of debt?
What is the cost of equity?
What is the cost of capital for the $2 million?

Solution Preview

What is the cost of debt?

Cost of debt is equal to the current yield to maturity of the bonds, which is 9.5%.

What is the cost of equity?

Cost of equity can be found by using the following formula.

rs = rf + (rm - rf)b where rs is the stock's required rate of return
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Solution Summary

This solution is comprised of a detailed explanation to answer the cost of debt, cost of equity, and cost of capital.

$2.19