Calculate the cost of equity and ABC'S target capital structure weights

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Using DFC method company ABC earned pretax operating income of $750,000. Income has grown 2% annually during the last 5 years and is expected to continue growing at that rate for the next 2 years. Net operating working capital increased by $60,000 during the current year and current year capital spending on long-lived assets exceeded depreciation by $75,000. working capital and the excess of capital spending over depreciation are projected to grow at the same rate as operating income. Subsequent to the second year, you believe the pretax operating income growth rate will increase to 3% per year and remain at that level into the future. The 10-year Treasury bond rate is 2.5%, the equity risk premium is 5.5%, and the marginal federal, state and local tax rate is 35%. Abc’s beta and its target debt-to-equity ratio are 1.74 and 0.67, respectively. Its pretax cost of borrowing, based on its recent borrowing activities, is 9%. Calculate the cost of equity and ABC’S target capital structure weights

 

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