Question

The capital structure of Global Motors is as follows: 55% common stock; 10% preferred stock; and 35% long term debt. The expected risk premium of Global Motor’s stock vs. US long-term Govt bonds is 7.5%. The 20-year US long-term Govt. default-free bond yield is 6.0%. The company’s credit rating is A- and the credit spread for 20-year A- corporate debt is 1.0%. Global Motor’s tax rate is 30%.

Answer 1

This question pertains to calculating Global Motors' cost of capital using its capital structure, risk premium, bond yields, credit spread, and tax rate.

Step-by-step explanation:

The question is related to determining the cost of capital for Global Motors, which has a specific capital structure comprising common stock, preferred stock, and long-term debt. We need to calculate the cost of each component of the capital structure using the given risk premium for common stock, the yield of long-term government bonds, the credit spread for A- corporate debt, and the company’s tax rate. The cost of equity can be determined by adding the expected risk premium of Global Motor’s stock to the yield of the long-term government bonds. The cost of debt is calculated by adding the corporate credit spread to the government bond yield and then adjusting for taxes. The costs are then weighted according to the proportions in the company’s capital structure to determine the overall cost of capital.