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The Tiptop corporations senior finance manager is having difficulties in calculating its cost of capital. You have been recently hired and given the task of

The Tiptop corporations senior finance manager is having difficulties in calculating its cost of capital. You have been recently hired and given the task of calculating the cost of capital of the company (i.e., WACC). You will use the following information to calculate the WACC.

The firm does not have any publicly traded debt. The book value of the firms debt is $4 million. By examining the public debt of similar companies, you conclude that the market value of the debt of the firm should be 80% of the book value of the debt, and the YTM should be 7%.

The company has one million shares of common equity with a par (book) value of $2 and retained earnings of $50 million. Given that the company pays dividends on a regular basis and your faith in CAPM, you have decided that you will estimate the cost of equity using the following weighted average method: cost of equity = 60% (cost of equity estimated by CAPM formula) + 40% (cost of equity estimated by the dividend discount model). The companys stock is trading at $10 per share. The companys next expected dividend is $1 per share, and the dividends are expected to grow at a rate of 4%. The risk-free rate is 5%, and the market risk premium is 5%. The equity beta of the company is 1.5.

The firm had preferred shares till last year. However, the company went through a financial restructuring, and repurchased those shares 6 months ago. The repurchase price was $7 per share when the preferred shares were yielding a return of 12%. Finally, the company faces a tax rate of 35%. What is your estimate of Tiptops WACC? 12 points.

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