Blackbeans Inc. went public 15 years ago and its IPO was a huge success. The stock price has risen from its initial issue price of $5 to its current level of $72 per share. There are currently 8 million shares outstanding. The company issued 30-year semi-annual bonds at par, with a face value of $1,000 and a coupon rate of 6.25% and managed to raise $125 million for expansion about 10 years ago. Today, the AA-rated bonds have 20 years to maturity and are being quoted at 101.125 (the quote is in decimal).

The firm is currently at its target capital structure and plans to maintain around its target in the foreseeable future. Growth rates in dividends and earnings would continue at its current rate. Corporate tax rate is 35%.

The firm has three close industry peers with the following information:

Firm A: 21% debt/79% equity, levered beta of 1.80

Firm B: 28% debt/72% equity, levered beta of 1.35

Firm C: 12% debt/88% equity, levered beta of 2.42

10-year Treasury bond yield is 2% and the market risk premium based on historical market risk premium analysis is 5.5%.

Answer the following question related to cost of capital estimation.

1. How should we go about figuring out the cost of debt? Calculate the firm’s cost of debt. (Round cost of debt in percent to 4 decimal places, e.g., 1.2345%)

2. How can we estimate the firm’s cost of equity (or cost of retained earnings)? (Round all intermediate and final numbers to 4 decimal places, e.g., 1.2345 or 1.2345%)

Answer rating: 100% (QA)

1 The cost of debt is the rate a company pays on its debt such as bonds and loans The k... View the full answer