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A specialty goods company based in India is considering establishing manufacturing facilities in the United States through a wholly owned subsidiary. It has approached two

A specialty goods company based in India is considering establishing manufacturing facilities in the United States through a wholly owned subsidiary. It has approached two different investment banking advisors; Investor advisor A and Investor advisor B for estimates of what its costs of capital would be several years into the future when it planned to list its American subsidiary on a U.S. stock exchange. The following assumptions are provided by the two different advisors:

Assumptions

Investor advisor A

Investor advisor B

Estimated beta:

1.20

1.15

Risk-free rate of interest

2.5%

2.5%

Estimate of Companys cost of debt in US market

7.2%

7.5%

Expected rate of return on market portfolio of stocks

9.5%

12.2%

Corporate tax rate

35.0%

35.0%

Proportion of debt

40%

45%

Proportion of equity

60%

55%

Using the assumptions listed above, calculate for each Investor advisor:

  1. a) the companys cost of equity (2 marks)
  2. b) the companys cost of debt (2 marks)
  3. c) the companys weighted average cost of capital (2 marks)

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