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Problem 4: DETERMINING THE COST OF CAPITAL FOR RETAIL, INC. Suppose an equity analyst needs to determine the cost of capital for the company Retail,

Problem 4: DETERMINING THE COST OF CAPITAL FOR RETAIL, INC. Suppose an equity analyst needs to determine the cost of capital for the company Retail, Inc., which has asignificant amount of operating lease commitments and some conventional debt. The analyst has collected thefollowing information:

There are two classes of shares outstanding: 12 million non-voting shares that trade at a price of $10per share, and 2.5 million non-voting shares that do not trade, but have an estimated DCF-value of$12 per share.

The firm has a bank loan on its books with a face value of $50 million and a remaining maturity of 5years. The loan was issued 5 years ago at par at an interest rate of 5%, and will be repaid in full atmaturity. The firm is rated BBB, and the current market yield on BBB-rated bonds equals 6%.

The firm has expected annual operating lease commitments of $15 million for the next 8 years.

The cost of equity for Retail, Inc. equals 10%, and the marginal tax rate equals 40%.

Determine the cost of capital for Retail, Inc. Motivate your approach and show your calculations.

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