Friends Corp. is an e-commerce company. Its management plans to start its own package delivery business (new to the firm) to be financed only with equity. Abel Logistics and Finish Enterprise are two firms that specialize in this package delivery business. You are given the following financials for these firms:

Friends Corp. currently has a stock price of $18 per share with 25 million shares outstanding. Its market value of debt is $300 million. The company has a debt of 0.1, an equity beta of 1.63 and a tax rate of 21%.
Abel Enterprise is an all-equity financed firm with a market capitalization of $250 million. The company has an equity beta of 1.6 and faces a tax rate of 21%.
Finish Logistics has a stock price of $15 per share with 20 million shares outstanding. Its market value of debt is $300 million. The company has a debt of 0.2, an equity beta of 1.8 and a tax rate of 21%.
Assume the risk-free is 1% and the expected market risk premium is 5%. If the management of Friends Corp. asks for an estimate of the cost of capital with a small estimation error, then your estimate of the cost of capital for Friends package delivery business is ........%. Note that if you have several appropriate estimates, then just take the simple average of these estimates as your final cost of capital to minimize the estimation error.

Please provide a step-by-step explanation.

Answer rating: 100% (QA)

Step 1 Calculate the cost of equity for Friends Corp The cost of equity represents the return requir... View the full answer