Using the capital asset pricing model, the cost of equity capital for a company in this industry

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Using the capital asset pricing model, the cost of equity capital for a company in this industry with a debt-to-equity ratio of 0.01, asset beta of 2.27, and a marginal tax rate of 23% is closest to:

A. 17%.

B. 21%.

C. 24%.

Boris Duarte, CFA, covers initial public offerings for Zellweger Analytics, an independent research firm specializing in global small-cap equities. He has been asked to evaluate the upcoming new issue of TagOn, a U.S.-based business intelligence software company. The industry has grown at 26 percent per year for the previous three years. Large companies dominate the market, but sizable “pure-play” companies such as Relevant, Ltd., ABJ, Inc., and Opus Software Pvt. Ltd also compete. Each of these competitors is domiciled in a different country, but they all have shares of stock that trade on the U.S. NASDAQ. The debt ratio of the industry has risen slightly in recent years.

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Duarte uses the information from the preliminary prospectus for TagOn’s initial offering. The company intends to issue 1 million new shares. In his conversation with the investment bankers for the deal, he concludes the offering price will be between \($7\) and \($12\).
The current capital structure of TagOn consists of a \($2.4\) million five-year noncallable bond issue and 1 million common shares. Other information that Duarte has gathered:

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Corporate Finance A Practical Approach

ISBN: 9781118217290

2nd Edition

Authors: Michelle R Clayman, Martin S Fridson, George H Troughton, Matthew Scanlan

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