20.07.2022 - 01:24

# The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions). Total Assets $6,840 Interest-Bearing Debt$3,562 Average Pre-tax borrowing cost 11.5% Common E

Question:

The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions).

 Total Assets $6,840 Interest-Bearing Debt$3,562 Average Pre-tax borrowing cost 11.5% Common Equity: Book Value $2,560 Market Value$12,850 Income Tax Rate 35% Market Equity Beta 1.24

Assuming that riskless rate is 4.2% and the market premium is 6.2%, calculate Zolar’s cost of equity capital (i.e. the required rate of return on equity).

• Zolar Corp.'s cost of equity capital is 12.08%. The formula to calculate the cost of equity capital is: Cost of Equity = Risk-free Rate + Beta x Market Premium Using the data provided, we can plug in the values: Risk-free Rate = 4.2% Market Premium = 6.2% Market Equity Beta = 1.24 Cost of Equity = 4.2% + 1.24 x 6.2% Cost of Equity = 4.2% + 7.688% Cost of Equity = 11.89% However, we need to adjust for the income tax rate of 35% since the cost of equity is calculated based on after-tax income. We can do this by dividing the cost of equity by (1 - income tax rate): Cost of Equity = 11.89% / (1 - 35%) Cost of Equity = 11.89% / 0.65 Cost of Equity = 18.29% Now we have the pre-tax cost of equity, but we need to adjust for the difference between the market value and book value of Zolar's common equity. We can do this by calculating the market value proportion of the equity using the formula: Market Value Proportion = Market Value of Equity / Total Market Value Market Value Proportion = $12,850 million / ($12,850 million + $6,840 million) Market Value Proportion = 0.652 Now we can calculate the weighted average cost of equity by multiplying the pre-tax cost of equity and the market value proportion, and adding it to the cost of debt multiplied by 1 minus the tax rate: Weighted Average Cost of Equity = (Market Value Proportion x Pre-tax Cost of Equity) + (1 - Market Value Proportion) x (Cost of Debt x (1 - Tax Rate)) Weighted Average Cost of Equity = (0.652 x 11.89%) + (0.348 x (Interest-Bearing Debt / Total Assets) x (Average Pre-tax borrowing cost x (1 - Income Tax Rate))) Weighted Average Cost of Equity = (0.652 x 11.89%) + (0.348 x ($3,562 million / $6,840 million) x (11.5% x (1 - 35%))) Weighted Average Cost of Equity = 7.77% + 1.57% Weighted Average Cost of Equity = 9.34% Therefore, Zolar Corp.'s cost of equity capital is 9.34%. Do you know the answer? Not sure about the answer? Find the right answer to the question The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions). Total Assets$6,840 Interest-Bearing Debt \$3,562 Average Pre-tax borrowing cost 11.5% Common E by subject Business, and if there is no answer or no one has given the right answer, then use the search and try to find the answer among similar questions.