You have been asked to estimate the cost of capital for the CAT corporation. The company has

Question:

You have been asked to estimate the cost of capital for the CAT corporation. The company has 4 million shares and 125,000 bonds of par value $1,000 outstanding. In addition, it has $20 million in short-term debt from its bank. The target capital structure ratio is 55 percent equity, 40 percent long-term debt, and 5 percent short-term debt. The current capital structure has temporarily moved slightly away from the target ratio.

The company’s shares currently trade at $50 with a beta of 1.03. The book value of the shares is $16. The annual coupon rate of the bonds is 9 percent, they trade at 108 percent of par, and they will mature in ten years. Interest on the short-term debt is 3.5 percent. The current yield on ten-year government bonds is 5.2 percent. The market risk premium is 5 percent. The corporate tax rate applicable is expected to be 35 percent.

Based on these data, calculate the cost of capital for the CAT corporation.

Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...