Question

Oriole Corporation is financed with debt, preferred equity, and common equity with market values of $23 million, $14 million, and $31 million, respectively. The betas for the debt, preferred stock, and common stock are 0.3, 0.5, and 1.1, respectively. The risk-free rate is 3.88 percent, the market risk premium is 6.05 percent, and Oriole's average and marginal tax rates are both 30 percent. Excel Template (Note: This template includes the problem statement as it appears in your textbook. The problem assigned to you here may have different values. When using this template, copy the problem statement from this screen for easy reference to the values you've been given here, and be sure to update any values that may have been pre-entered in the template based on the textbook version of the problem.) (a1) . Your answer is incorrect. What is the company's cost of capital? (Round intermediate calculation to 4 decimal places, e.g. 1.2512 and final answers to 3 decimal places eg. 5.215%.) Costs of debt Costs of common equity Costs of preferred equity Attempts: 1 of 2 used Save for Later Submit Answer (a2) The parts of this question must be completed in order. This part will be available when you complete the part above.

Answer 1

As per CAPM, the expected return (or cost of different sources of finance) can be calculated as follows: Expected return=Risk-free rate+(Market risk premium Beta) Calculate the cost of debt as follows: Expected return=Risk-free rate +(Market risk premium Beta) = 3.88%+(6.05%x0.3) = 3.88%+1.815% =5.695% Thus, the cost of debt is 5.695%. But, cost of debt should be considered after-tax. The tax rate is given as 30%. Hence, calculate the after-tax cost of debt as follows: After-tax cost of debt=Cost of debt x (1 – Tax rate) =5.695%*(1-30%) =3.9865% Thus, the after-tax cost of debt is 3.987%. Now, calculate the cost of common equity as follows: Beta) Expected return=Risk-free rate+(Market risk premium = 3.88%+(6.05%x1.1) = 3.88%+6.655% =10.535% Thus, the cost of common equity is 10.535%.

Calculate the cost of preferred stock as follows: Expected return=Risk-free rate+(Market risk premium Beta) = 3.88%+(6.05%x0.5) = 3.88%+3.025% =6.905% Thus, the cost of preferred stock is 6.905%.