As of 2021, long-term US Treasury notes yield 1.40%. Coke's debt is rated A1 and stock beta is about 0.70. High grade corporate debt yields 3.50%, medium grade yields 4.30%, and low grade yields 6.10%. The firm is taxed at 21.00% and relies on long-term debt at $38 billion and equity at $25 billion for capital. The firm believes their capital structure is optimal. Management project the firm's net income will equal $10 billion during the next year and will pay dividends equal to $7.5 billion.

First estimate the weighted, average, after-tax cost of capital for coke when relying on retained earnings for equity. Estimate the cost of equity by the bond premium model: the equity premium (Rm-Kd) is estimated to be 5.00%. Derive the cost of debt from their credit ratings assigned and the market pricing of comparable quality debt.

Second identify the dollar breakpoint for the firms cost of capital when the company would no longer rely on retained earnings for the pro-rata share of capital but must issue common stock given projections of net income and dividends.

Third briefly indicate why Coke may wish to rely so heavily on long-term debt rathe than equity and how high the leverage might affect affect their cost of capital.

Answer rating: 100% (QA)

1 The weighted average cost of capital WACC is the weighted average cost to the firm of raising ne... View the full answer