A 20-year $1,000 fixed-rate non callable bond with 8% annual coupons currently sells for $1105.94 Assuming a 3O% marginal tax rate and an additional n sk premium for equity relative to debt of 5% the cost of equity using the bond-yield-plus-risk premium approach is closest to
First detemine the yield to matunity which is the discount rate that sets the bond price to $1.1O5.94 and is equal to 7%.This calculation can be done with a financial calculator.
FV=-$1,000,PV=$1,105,94,N =20,PMT=-$80,solvefor i,which will equa17%
The bond-yield-plus-risk-premium approach is calculated by adding a risk premium to the cost of debt (i.e the yield to maturity for the debt),maKing the cost of equity 12,OO% (= 7% +5%)