Question
You work for company Spring System. The company is planning to invest in a new business line. Your job is to estimate appropriate cost of
You work for company Spring System. The company is planning to invest in a new business line. Your job is to estimate appropriate cost of capital for this new expansion. To reduce estimation error, you collected two pure play companies in the new business area. Company A is an all-equity company which has equity beta 0.90. Company B has equity beta 1.20 and it has outstanding debt $100 million, shares outstanding 20 million with current stock price of $40 per share. Both pure plays have a zero-debt beta and a zero corporate tax rate. The company Spring Systems cost of debt is 3% (assume the debt-beta is zero). Company has debt-to-firm value ratio 30% and tax rate 25%. The target debt financing for the new expansion is 25%. Market risk premium is 4.60% and the risk-free rate is 1.70%. Compute an estimate of the weighted average cost of capital (WACC) for the new business.
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