Problem 5: CAPM and Cost of Capital
Columbia Gas Company (CGC) is a publicly listed company with acurrent share price of
$25 per share. CGC has 33 million shares outstanding and $100million in long-term debt. CGC’s long-term debt consists of bondsissued with a face value of $100 million with 10 years to maturitywith annual coupon rate of 11% (APR). The long-term bonds arecurrently trading at par value.
Columbia Gas Company (CGC) has a standard deviation of 36% anda correlation with the market of 0.85. Assume the risk-free rate is4% and the market portfolio has an expected return of 13% and astandard deviation of 22%. The corporate tax rate is 30%.
A. What are the three main assumptions of capital assetpricing model (CAPM)? Are these assumptions realistic in the realworld? Explain.
B. Calculate CGC’s beta with the market?
C. Calculate CGC’s cost of equity?
D. Calculate CGC’s after-tax cost of debt?
E. Calculate CGC’s weighted average cost of capital (WACC)?
