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AICPA Exam CPA-Business Topic 1 Question 62 Discussion
Topic #: 1
Additional Data
* The long-term debt was originally issued at par ($1,000/bond) and is currently trading at $1,250 per bond.
* Martin Corporation can now issue debt at 150 basis points over U.S. treasury bonds.
* The current risk-free rate (U.S. treasury bonds) is 7 percent.
* Martin's common stock is currently selling at $32 per share.
* The expected market return is currently 15 percent.
* The beta value for Martin is 1.25.
* Martin's effective corporate income tax rate is 40 percent.
Using the Capital Asset Pricing Model (CAPM), Corporation's current cost of common equity is:
Choice 'c' is correct. 17.00 percent. Using the CAPM model, Martin's current cost of common equity would be:
Cost of equity = Capital risk free rate + Beta (market rate risk free rate)
Cost of equity = 7% + 1.25 (15% 7%)
Cost of equity = 7% + 1.25 (8%)
Cost of equity = 7% + 10%
Cost of equity = 17%
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