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Strong Inc. has evaluated its capital structure. The balance sheet of the company is shown below (in millions of $): Assets Liabilities Current Assets 1,000 Debt 2,500 Non-current Assets 4,000 Equity 2,500 In addition, you are provided the following information: The debt is in the form of long-term bonds, with a coupon rate of 10%. The bonds are currently rated AA and are selling at a yield of 12% (The market value of the bonds is 80% of the face value). The firm currently has 50 million shares outstanding, and the current market price is $80 per share. The firm pays a dividend of $4 per share and has a price/earnings ratio of 10. The stock currently has a beta of 1.2. The risk-free rate is 8%. The tax rate for this firm is 40%.

(a) Calculate the firm’s debt/equity ratio in book value terms and in market value terms? Calculate the firm’s after-tax cost of debt, the firm’s cost of equity, and the firm’s current cost of capital?


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