1)

From the following data, calculate the cost of capital for operations (WACC). Use the capital asset pricing model to estimate the cost of equity capital.

U.S. Government long-term bond rate 4.3%

Market risk premium 5.0%

Equity beta 1.3

Per-share market price $40.70

Shares outstanding 58 million

Net financial obligations on balance sheet $1,750 million

Weighted-average borrowing cost 7.5%

Statutory tax rate 36.0%

2)

Explain why the cost of capital for operations is different from that for equity.

3)

A firm with a book value of $15.60 per share and 100% dividend payout is expected to have a ROE of 15% forever. Its cost of equity capital is 10%. Calculate its market value of equity using the abnormal earnings model.