Question

Estimating Cost of Capital Measures US Steel has $3.16 billion in total debt (which approximates its market value). Interest expense for the year was about $214.0 million. The company’s market capitalization is approximately $1.17 billion, its market beta is 2.65, and its assumed tax rate is 37%. Assume that the risk-free rate equals 2.5% and the market premium equals 5%

Rounding Instructions: Do not round until your final answers. Round answers to one decimal place.

(a) Estimate US Steel's cost of debt capital. Answer______ %

(c) Estimate US Steel's cost of equity capital. Answer________ %

(d) Using your rounded answers from (a) and (c) above, estimate US Steel's weighted average cost of capital.

Answer 1

After cost of debt is 4.27%

Cost of equity of 15.75%

WACC is 7.37%

Step-by-step explanation:

US Steel cost of debt can be ascertained dividing the interest expense by the total value of debt since that gives the percentage of the debt paid as coupon interest to bondholders;

cost of debt =$214.0million/$3,160.million=6.77%

after tax cost of debt(Kd) =7.13%*(1-0.37)=4.27%

Cost of equity can be computed using the below formula:

Ke=Rf+beta*(Mp)

Rf is the risk free rate of 2.5%

Mp is the market premium of 5%

beta is 2.65

Ke=2.5%

Ke=2.5%+(2.65*5%)=15.75%

WACC=Ke*E/V+Kd*D/V

E is weight of equity of 1.17

D is the weight of debt 3.16

V is the sum of the weights (1.17+3.16)=4.33

WACC=(15.75%*1.17/4.33)+(4.27%*3.16/4.33)=7.37%