Question

Key facts and assumptions concerning Kroger Company, at December 12, 2007, appear below. Using this information, answer the questions following.

Facts and Assumptions
Yield to maturity on long-term government bonds 4.54%
Yield to maturity on company long-term bonds 6.32%
Coupon rate on company long-term bonds 7.50%
Market price of risk, or risk premium 6.30%
Estimated company equity beta 1.05
Stock price per share $ 25.97
Number of shares outstanding 681.2 million
Book value of equity $ 4,965 million
Book value of interest-bearing debt $ 6,674 million
Tax rate 35.0%
a. Estimate Kroger's cost of equity capital.
b. Estimate Kroger's weighted-average cost of capital. Prepare a spreadsheet or table showing the relevant variables.

Answer 1

a. 11.16 %

b. 7.56 %

Step-by-step explanation:

Cost of equity capital is the return that is required by Common Stockholders.

This can be determined as follows :

1. Growth Model

Cost of equity = Recent dividend / Market Price of Share + Expected Growth Rate

or

2. Capital Asset Pricing Model (CAPM)

Cost of equity = Return on Risk Free Security + Beta × Return on Market Portfolio Security

= 4.54% + 1.05 × 6.30%

= 11.16 %

WACC = Ke × (E/V) + Kd × (D/V) +Kp × (P/V)

Explanation and value of Variables

Ke = Cost of Equity

= 11.16 %

E/V = Weight of Equity

= $ 4,965 ÷ ( $ 4,965 + $ 6,674)

= 42.66 %

Kd = Cost of Debt :

= Interest × (1 - tax rate)

= 7.50% × ( 1 - 0.35)

= 4.875 or 4.88 %

D/V = Weight of Debt

= $ 6,674 ÷ ( $ 4,965 + $ 6,674)

= 57.34 %

Therefore,

WACC = 11.16 % × 42.66 % + 4.88 % × 57.34 %

= 7.56 %