Question

The Nile Corporation has 9.4 million shares of common stock outstanding and 380,000 4 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $42 per share and has a beta of 1.2. The bonds have 10 years to maturity and sell for 113 percent of par. The market risk premium is 8.2 percent, T-bills are yielding 3 percent, and the company’s tax rate is 24 percent.

a. 12.80%
b. 14.50%
c. 15.75%
d. 17.20%

Answer 1

The question aims to calculate the cost of equity using the CAPM for Nile Corporation with information on stock beta, market risk premium, T-bill yield, and the company's tax rate, and it investigates how bond yields are influenced by market interest rates.

Step-by-step explanation:

The query pertains to calculating the cost of equity and the yield on bonds for Nile Corporation given various financial data, including the stock beta, market risk premium, T-bill yield, number of shares and bonds, and the company's tax rate. The Capital Asset Pricing Model (CAPM) is typically used to determine the cost of equity. The model considers the risk-free rate (yield on T-bills), the market risk premium, and the stock's beta. In this case, the cost of equity can be calculated using the CAPM formula: Cost of Equity = Risk-Free Rate + (Beta * Market Risk Premium). By plugging in the given information (3 percent risk-free rate, 1.2 beta, and 8.2 percent market risk premium), the cost of equity for Nile Corporation can be computed.

On the bond side, the yield or total return is affected by interest payments and capital gains or losses. When the interest rates rise, existing bonds with lower coupon rates decrease in price, and vice versa. The detailed answer provided also explains how a bond's yield is calculated based on its current price and the payments the bondholder will receive, which is essential knowledge for making investment decisions in the fixed income market.