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The following assumptions are used to determine the cost of capital . Historically, the company tried to maintain a debt to equity ratio equal to 0.

The following assumptions are used to determine the cost of capital

 

Historically, the company tried to maintain a debt to equity ratio equal to 0.40. This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 35%. 





Cost of debt:

The company's bond rating is roughly AAA. Surveying the debt market yielded the following information about the cost of debt for different rating levels:


The company's current bonds have a yield to maturity of about 4.25%.


Cost of equity:


The current 10-year Treasury notes have a yield to maturity of 2.25% and the forecast for the S&P 500 market premium is 7.5%.  The company's overall b is 1.25.

Top Answer

Answer Cost of capital = Weight of Equity*Cost of Equity + Weight... View the full answer

2 comments
  • thank you, I still don't think i even came close on my quiz. Thank you this is helpful
    • catpeguero
    • May 14, 2018 at 5:59pm
  • You are most welcome
    • rocky4ever
    • May 14, 2018 at 6:02pm

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