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The following assumptions are used to determine the cost of capital. Historically, the company has...

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Accounting

The following assumptions are used to determine the cost of capital.

Historically, the company has maintained a debt ratio is 50%. This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firms cash flow. In addition, increasing the debt level may cause a reduced rating of the companys bonds. The marginal tax rate is 40%. All the numbers are expressed in todays dollars. The forecasted average inflation per year is 2.5%.

Cost of debt:

The companys bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels:

Bond rating

AA

A

BBB

Interest cost range

5.5% ~ 6.5%

6.25% ~ 7.5%

7.5% ~ 9%

The companys current bonds have a yield to maturity of about 6.5%.

Cost of equity:

The current 10-year Treasury notes have a yield to maturity of 1.75% and the forecast for the S&P 500 market premium is 9.75%. The companys overall b is 1.25.

Please calculate and show the work for WACC

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