ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt
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ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100, 6% coupon rate, and 10 years to maturity. The common stock has a standard deviation of return of 30% and a correlation coefficient with S&P 500 return of 0.75. The S&P500 has a return of 12.5% and a standard deviation of return of 20%. The T-bill rate is 3.5%. The debt has a default risk premium of 2% and a maturity risk premium of 1%. The stockholders are expected to receive a dividend of $2 five years hence and a stock price of $105 five years hence. ABC Inc. has a corporate tax rate of 30%.
- Determine the cost of common stock, and the cost of debt.
- What is the capital structure of ABC? (How much of the capital is raised by issuing common stock and debt, respectively?)
- Determine the weighted average cost of capital.
- If return on an investment is 10%, is the investment acceptable? Explain.
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