What specific items of capital should be included in a corporate cost of capital estimate? Should historical (embedded) or new (marginal) values be used? Why?
Estimate of Southern's cost of debt:
What is your estimate of Southern’s cost of debt?
Should flotation costs be included in the cost of debt calculation? Explain.
Should the stated (nominal) cost of debt or the effective annual rate be used? Explain.
Any new long-term debt issued by the company will likely have a 30-year maturity. How valid is an estimate of the cost of debt based on 15-year bonds? If the estimate is not valid, how might it be adjusted to remove any bias?
Suppose the company’s outstanding debt had not been recently traded; what other methods could be used to estimate the cost of debt?
Cost associated with retained earnings:
Why is there a cost associated with retained earnings?
What is the company’s estimated cost of equity using the CAPM approach?
Why is the T-bond rate used to proxy the risk-free rate rather than the T-bill rate?
How do historical betas, adjusted historical betas, and fundamental betas differ?
How can the market risk premium be estimated?
Discounted cash flow:
Use the discounted cash flow (DCF) method to obtain a cost of equity estimate.
The firm, over the last few years, has had a 20 percent average return on equity (ROE) and has paid out about 50 percent of its net income as dividends. Under what conditions could this information be used to help estimate the Southern's expected future dividend growth rate?
Use the debt cost (bond yield) plus risk premium method to estimate the cost of equity.
What is your final estimate for Southern’s cost of equity? Explain your answer.
What is your estimate for Southern’s corporate cost of capital?