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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