Problem 5: CAPM and Cost of Capital (20 marks)

Columbia Gas Company (CGC) is a publicly listed company with a current share price of

$25 per share. CGC has 33 million shares outstanding and $100 million in long-term debt. CGCs long-term debt consists of bonds issued with a face value of $100 million with 10 years to maturity with annual coupon rate of 11% (APR). The long-term bonds are currently trading at par value.

Columbia Gas Company (CGC) has a standard deviation of 36% and a correlation with the market of 0.85. Assume the risk-free rate is 4% and the market portfolio has an expected return of 13% and a standard deviation of 22%. The corporate tax rate is 30%.

A. What are the three main assumptions of capital asset pricing model (CAPM)? Are these assumptions realistic in the real world? Explain. (6 marks)

B. Calculate CGCs beta with the market? (3 marks)

C. Calculate CGCs cost of equity? (3 marks)

D. Calculate CGCs after-tax cost of debt? (3 marks)

E. Calculate CGCs weighted average cost of capital (WACC)? (5 marks)