Seacrest Corporation is a privately- owned chemical company, that is expected to generate a return on equity of 20% next period and is in stable growth, growing 4% a year in perpetuity. Publicly traded chemical companies in stable growth, growing 4% a year, have a return on equity of only 12% and trade at 1.6 times book value. If publicly tradedchemical companies are fairly priced and only 40% of the risk in a chemical company is market risk, estimate the price to book ratio for Seacrest. (The owner has his entire wealth invested in the company; the riskfree rate is 4% and the equity risk premium is 5%). Hint: PBV = (ROE-g) / (k-g) A. 2.5 B. 2.12 C. 1.54 D. 1.28
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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