Given the following:
(1) The firm's net tax rate is 25%.
(2) The current price of ABS Corporation’s 12% coupon, semiannual payment, noncallable bonds with 15
years remaining to maturity is $1,153.72. There are 70,000 bonds outstanding. ABS Corp. does not use
short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no
flotation cost.
(3) The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is
$116.95. ABS would incur flotation costs equal to 5% of the proceeds on a new issue. There are 200,000
preferred shares outstanding.
(4) ABS's common stock is currently selling at $50 per share. There are 3 million outstanding common
shares. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in
the foreseeable future. ABS's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is
estimated to be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a
3.2% judgmental risk premium.
(5) ABS's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.

Estimate ABS’s Cost of Capital. To assist you in calculating this estimate, answer the following questions:

a. What sources of capital should be included when you estimate ABS's weighted average
cost of capital (WACC)?
b. What is the market interest rate on ABS's debt and what is the component cost of this
debt for WACC purposes?
c. What is the firm's cost of preferred stock?
d. ABS Corp. does not plan to issue new shares of common stock. Using the CAPM
approach, what is ABS's estimated cost of equity?
e. What is the estimated cost of equity using the dividend growth approach?
f. What is the cost of equity based on the over-own-bond-yield-plus-judgmental-risk-
premium method?
g. What is your final estimate for the cost of equity, rs?
h. ABS’s target capital structure is 30% long-term debt, 10% preferred stock, and 60%
common equity. How does this compare with the current market value capital
structure? What is ABS's weighted average cost of capital (WACC)?

Answer rating: 100% (QA)

ABS Corporations Cost of Capital WACC Estimation a Sources of Capital for WACC The following sources of capital should be included when estimating ABS... View the full answer