Question
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:
- a) the companys cost of equity
- b) the companys cost of debt
- c) the companys weighted average cost of capital
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