Aswath Damodaran 354
Bookscape’s current cost of capital
! We assumed that Bookscape would have a debt to capital ratio of 16. 90 %,
similar to that of publicly traded book retailers, and that the tax rate for the
firm is 40 %. We computed a cost of capital based on that assumption.
! We also used a “total beta”of 2. 0606 to measure the additional risk that the
owner of Bookscape is exposed to because of his lack of diversification.
! Cost of Capital
- Cost of equity = Risfree Rate + Total Beta Risk Premium
= 4 % + 2. 0606 4. 82 % = 13. 93 %
- Pre-tax Cost of debt = 5. 5 % (based upon synthetic rating of BBB)
- Cost of capital = 13. 93 % (. 8310 ) + 5. 5 % ( 1 -. 40 ) (. 1690 ) = 12. 14 %
Note that we use the total beta rather than market beta to estimate the cost of
equity. This will increase the cost of equity at every debt ratio.
