4. Assume the investment banker also wants you to use the capital asset pricing model (CAPM, as shown on p. 388 in the text), to compute the cost (required return) on common stock. Assume the risk free rate (r_RF) is 4.8%, beta for the firm is 1.10, and the market risk premium (RP_M) is 8.2%.

a. What is required rate of return for common equity using this method? and

b. How does it compare to the required rate of return computed in Question 1 above?

a. Determine the weights of each component in the capital structure: use the amount of retained earnings provided. The percentage composition (weights) in the capital structure for bonds, preferred stock and common equity should be based on the current capital structure total long-term financing as shown in Figure 1. Common equity will represent approximately 60% of long term financing throughout the case, and the combined tax rate is 40%.

b. Compute the cost for each component in the capital structure (after-tax cost of debt, cost of preferred stock, and cost of equity). Use your calculator (or Excel) to solve for the interest rate (I).

c. Using the results from above, calculate the weighted average cost of capital (WACC).

North of the Border Sensors Inc. Statement of Financial Position: Balance Sheet December 31, 2016 Assets rent assets: Cash Marketable securitles Accounts rece vable $ 300,000 150,000 Less: Allowance for bad debts 5,600,000 otal current assets $ 8,350,000 Fixed assets: Plant and equipment, original cost $ 31,300,000 Less: Accumulated depreclation Net plant and equipment 17,900,000 otal assets Liabilities and Owners' Equity t liabilities: Accounts payable Accrued expenses $5,750,000 1,950,000 $ 7,700,000 otal current lablities Long-term financing $ 6,180,000 Bonds payable Preferred stock Common stock Retained earnings $ 6,100,000 { Common equity 5,050,000 Total common equity 150,000 Total long-term financing 18,550,000 Total liabilites and equity North of the Border Sensors Inc. Statement of Financial Position: Balance Sheet December 31, 2016 Assets rent assets: Cash Marketable securitles Accounts rece vable $ 300,000 150,000 Less: Allowance for bad debts 5,600,000 otal current assets $ 8,350,000 Fixed assets: Plant and equipment, original cost $ 31,300,000 Less: Accumulated depreclation Net plant and equipment 17,900,000 otal assets Liabilities and Owners' Equity t liabilities: Accounts payable Accrued expenses $5,750,000 1,950,000 $ 7,700,000 otal current lablities Long-term financing $ 6,180,000 Bonds payable Preferred stock Common stock Retained earnings $ 6,100,000 { Common equity 5,050,000 Total common equity 150,000 Total long-term financing 18,550,000 Total liabilites and equity