Question

Zonk corp. the following data pertains to zonk corp., a manufacturer of ball bearings (dollar amounts in millions): total assets $7,460 interest-bearing debt $3,652 average pre-tax borrowing cost 10.5% common equity: book value $2,950 market value $13,685 income tax rate 35% market equity beta .60 assuming that riskless rate is 4.6% and the market premium is 7.3%, calculate zonk's cost of equity capital:

a. 11.9%
b. 10.5%
c. 6.8%
d. 8.98%

Answer 1

The cost of equity for Zonk Corp. is calculated using the CAPM formula. With a risk-free rate of 4.6%, a beta of 0.60, and a market risk premium of 7.3%, the cost of equity comes out to be 8.98%, corresponding to option (d) 8.98%.

Step-by-step explanation:

Calculating Zonk Corp's Cost of Equity Capital

To calculate the cost of equity for Zonk Corp., we apply the Capital Asset Pricing Model (CAPM), which is expressed by the formula:

Cost of Equity = Risk-Free Rate + (Beta * Market Risk Premium)

The risk-free rate is given as 4.6%, the equity beta is 0.60, and the market risk premium is the difference between the expected rate of return on the market and the risk-free rate, which is 7.3%. Plugging these values into the CAPM formula:

Cost of Equity = 4.6% + (0.60 * 7.3%)

The calculation is as follows:

• 0.60 * 7.3% = 4.38%
• Cost of Equity = 4.6% + 4.38%
• Cost of Equity = 8.98%

Hence, the cost of equity capital for Zonk Corp. is 8.98%, which corresponds to option (d) 8.98%.