| Course | GF520 Corporate Finance |
|---|---|
| Unit | Unit 3 |
| Paper type | Cost of capital computation |
| Length | About 930 words, 6 pages double-spaced |
| Format | APA 7 student paper |
| School | Purdue University Global |
| Program | MS in Finance |
| Updated | October 2026 |
Free sample paper for GF520 Unit 3
From Bond Price to Discount Rate: A Unit 3 Cost of Capital Computation for a Water Heater Maker
[Student Name]
Purdue University Global
GF520: Corporate Finance
Unit 3 Cost of Capital Computation
[Instructor Name]
[Date]
The company, its securities and every market figure are composite and illustrative; the articles and textbook cited are real.
The Company and Its Capital
The company sells water heaters through plumbing wholesalers and home improvement chains. Its capital comes from three sources: 600,000 publicly traded bonds of $1,000 face value, with a 5.5 percent coupon paid semiannually and eight years to maturity; 975,610 preferred shares paying a fixed $6.00 a year; and 27.5 million common shares trading at $56.00. Its marginal tax rate is 24 percent. Each source is costed at today's market terms, because the rate is meant for new projects, which must earn what investors require now, not what they required when the securities were first sold.
Block 1: Cost of Debt
Given. Bonds trade at 94.20 percent of face value. The coupon is 5.5 percent, paid as $27.50 every six months, with sixteen payments left.
Method. The coupon rate is not the cost of debt; the yield to maturity is, because it is what a new buyer earns at today's price. Solve for the semiannual rate at which sixteen payments of $27.50 and $1,000 at maturity, each discounted, add to $942.00, then double it.
Result. A yield to maturity of about 6.44 percent a year.
After tax. Interest is deductible, so the after-tax cost is 6.44 percent times one minus 0.24, or about 4.89 percent.
Meaning. The bonds sell below face value because market rates have risen since they were issued; a new bond today would need a coupon near 6.44 percent to sell at par.
Block 2: Cost of Preferred Stock
Given. A fixed $6.00 annual dividend and a price of $82.00.
Method. Preferred dividends behave like a perpetuity, so the cost is the dividend divided by the price. No tax adjustment applies, since preferred dividends are not deductible.
Result. $6.00 divided by $82.00, or 7.32 percent.
Block 3: Cost of Common Equity, Estimated Twice
Common equity has no stated payment, so its cost must be estimated from a model. Two models are used because each rests on assumptions the other does not share.
The capital asset pricing model. The ten-year Treasury yield is 4.3 percent, the company's beta estimated from sixty months of returns against a broad stock index is 1.15, and the market risk premium is taken as 5.5 percent. Adding a risk charge of 6.33 points, the beta of 1.15 multiplied by the 5.5-point premium, to the 4.3 percent yield gives 10.63 percent. Surveys of finance officers find that this is the most widely used method among large firms (Graham & Harvey, 2001).
The dividend growth model. Next year's dividend is expected to be $2.60, and analysts expect long-run growth of about 5.6 percent. Cost of equity equals $2.60 divided by $56.00, or 4.64 percent, plus 5.6 percent, giving 10.24 percent.
Reconciling the two. The estimates differ by about 0.39 points. The capital asset pricing model depends on a beta measured from past returns and on a premium that cannot be observed directly, and tests of the model find that beta alone explains returns less well than the theory predicts (Fama & French, 2004). The growth model depends on a growth rate that must be sustainable forever. Neither is clearly better here, so the estimate used is the average, 10.43 percent.
A single cost of equity figure hides two different bets, one on how the market prices risk and one on how fast the company can grow, so reporting both and explaining the gap tells the reader how much confidence the final rate deserves.
Block 4: Market Value Weights
Equity. 27.5 million shares at $56.00, or $1.54 billion.
Debt. 600,000 bonds at 94.20 percent of $1,000 face value, or about $565 million.
Preferred. 975,610 shares at $82.00, or about $80 million.
Total. About $2.185 billion. The weights are 70.5 percent equity, 25.9 percent debt and 3.7 percent preferred.
Market values are used rather than book values because investors' claims are priced at market. Book equity, in particular, reflects past retained earnings and bears little relation to what shareholders could sell their stake for today (Brealey et al., 2023).
Summary: The Weighted Average Cost of Capital
1. Equity: 70.5 percent times 10.43 percent contributes 7.35 points.
2. Debt: 25.9 percent times 4.89 percent contributes 1.27 points.
3. Preferred: 3.7 percent times 7.32 percent contributes 0.27 points.
The blended rate comes to roughly 8.89 percent.
Checks and Sensitivity
Two checks support the result. The after-tax cost of debt sits below the preferred cost, which sits below the cost of common equity, the ordering expected because each claim ranks below the previous one. And the rate is close to what a firm of this beta and debt level would carry in most published estimates.
Of all the inputs, the equity estimate moves the result most. Using the capital asset pricing model alone gives about 9.02 percent; using the growth model alone gives about 8.75 percent. A project with a return between those two figures should be studied further before approval.
How the Rate Should Be Used
The 8.89 percent rate applies to projects of average risk for this company, such as replacing production equipment or extending existing product lines. A project riskier than the company's normal business, such as entering a new market, needs a higher rate, and the next unit's capital budgeting analysis will make that adjustment explicitly.
References
Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.
Fama, E. F., & French, K. R. (2004). The capital asset pricing model: Theory and evidence. Journal of Economic Perspectives, 18(3), 25-46. https://doi.org/10.1257/0895330042162430
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7
Reading the GF 520 Unit 3 instructions
The third GF520 unit has you price each of a company's securities and blend them into one discount rate. Cost each source separately. For debt, use the yield to maturity on traded bonds rather than the coupon, and adjust for tax. For preferred stock, divide the fixed dividend by the price. For common equity, estimate the cost with at least one model, and preferably two, such as the capital asset pricing model and a dividend growth model, explaining any gap between them. Weight each source by its market value, not its book value, and say why. Combine the pieces into one rate and check that the ordering of costs makes sense. Test how much the result moves with the equity estimate. End with the kind of project the rate fits. Cite research on how firms estimate these figures in APA 7.
How the GF 520 Unit 3 example is put together
The example begins by describing the company's three kinds of capital and why market terms matter for new projects. Block 1 solves the bond yield from a price of 94.20 and sixteen semiannual coupons, then applies the 24 percent tax rate. Block 2 treats preferred dividends as a perpetuity. Block 3 builds the capital asset pricing estimate, citing Graham and Harvey's survey on how widely it is used, then the dividend growth estimate, and reconciles them with Fama and French's evidence on beta. The highlighted sentence explains that one equity number hides two different bets. Block 4 computes market values and explains why book equity misleads. A three-line summary shows each source's contribution, a checks section confirms the ordering of costs, and the close limits the rate to projects of average risk.
Where the points sit in the GF520 Unit 3 rubric
Most of the credit in this computation rests on correct inputs for each source. Graders check that the cost of debt is a yield to maturity adjusted for tax, that the preferred cost is computed without a tax adjustment and that equity costs come from a clearly stated model with sourced inputs. Showing two equity estimates and explaining the difference earns analytical credit in GF520, because it shows the student knows the figure is an estimate. Market value weights are expected; book weights usually cost points unless justified. A final rate with each contribution shown, a reasonableness check and a sensitivity line complete the technical part. Explaining which projects the rate suits demonstrates judgment, and APA 7 references to the research used finish the grade.
GF520 Unit 3 help from the desk
A frequent GF520 Unit 3 mistake is using the coupon rate as the cost of debt, which ignores what the market now demands. Others forget the tax adjustment on debt or apply one to preferred dividends. Equity is often estimated with a single model whose inputs are unsourced, such as a beta with no date. Weights are taken from the balance sheet. Some computations stop at the final rate without asking whether it makes sense. Many students then apply the firm's rate to every project. If your case firm has no traded bonds or no preferred stock, adjust the blocks but keep the logic: market terms for each source, two equity estimates if possible, market weights and a stated use for the result.
Get a GF520 Unit 3 example written to your instructions
Share whatever market data your GF520 Unit 3 case supplies, such as bond prices, beta, dividend history and share count, along with the prompt and rubric. The computation is built component by component from those inputs, with each estimate sourced and the weights taken at market value. As a first custom sample it comes free, typically inside 24-48h. The paper above is an original model document written by our desk, not a submitted student paper and not an official Purdue University Global document.
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GF520 Unit 3 questions, answered
Which equity risk premium should the computation use?
One that can be sourced and dated. Published estimates vary, from historical averages near six percent to implied premiums closer to four or five, and graders accept a range as long as the choice is explained. The sample uses 5.5 percent and names its basis in a footnote; if your case supplies a premium, the custom version uses that figure instead of choosing one.
What if the firm has no traded bonds?
Then the cost of debt is estimated another way, usually from yields on bonds of similar rating and maturity, or from the rate on the firm's most recent bank loan. The sample would state which proxy it used and why. A synthetic rating built from interest coverage is a common graduate approach when a case offers only financial statements and no market prices.
Why not use the target capital structure?
A target is appropriate when the firm has announced one and is moving toward it, and some prompts ask for exactly that. Without such evidence, current market weights reflect the mix investors are actually pricing. The sample uses market weights and notes that a stated target would change the result, which lets a grader see the choice was deliberate rather than accidental.
Where can I find a free GF520 Unit 3 sample paper?
This page carries a full GF520 Unit 3 cost of capital computation for a composite water heater maker, costing debt, preferred and common equity, weighting at market values and APA 7 references.
Why do the two equity estimates differ?
Each rests on its own assumptions. The capital asset pricing model depends on a historical beta and an unobservable market premium, while the growth model depends on a growth rate assumed to last forever, so a gap of a fraction of a point is normal.