No excel or financial calculator, please.

13. Cloned Cow Dairy Farms (CC) is a private company that operates a group of dairy farms in Wisconsin where the state motto is "Come Smell Our Dairy Air". Four years ago, CC raised funds through a bond offering with a term to maturity of five years. The bonds, which mature in one year, have a face value of $1000, a current price of $1038.32 and a coupon rate of 11.11% paid annually. CC is taxed at a rate of 40%.

a. Calculate the cost of debt for the company. (Hint: it is either 7%, 8%, or 9%)

b. A comparable company, Dolly Sheep is trading on the stock market. Dollys shares are highly correlated with the market the coefficient of correlation between Dolly and the market is 0.7. If the standard deviation of Dolly Sheep is 12% and that of the market is 16%, compute Dollys beta. Dolly is taxed at the same rate as CC.

c. If the expected return on the market is 14% and the risk-free rate is 6%, compute the cost of equity capital for Dolly Sheep.

d. If CC has a 20% debt-to-value ratio, what is the overall cost of capital for CC?

Answers:

7%, 0.525, 10.2%, 9.00%