Estimating the Cost of Equity Capital
Kellogg Company manufactures cereal and other convenience food under its many well-known brands such as Kellogg’s®, Keebler®, and Cheez-It®. The company, with over $13.5 billion in annual sales worldwide, partially finances its operation through the issuance of debt. At the beginning of its 2015 fiscal year, it had $6.5 billion in total debt. At the end of fiscal year 2015, its total debt had increased to $6.6 billion. Its fiscal 2015 interest expense was $227 million, and its assumed statutory tax rate was 37%. Kellogg has an estimated market beta of 0.70. Assume that the expected risk-free rate is 2.5% and the expected market premium is 5%.
a. What does Kellogg’s market beta imply about its stock returns?
A beta of 0.70 indicates Kellogg’s stock is less volatile than the market index.
A beta of 0.70 indicates Kellogg’s stock is more volatile than the market index.
A beta of 0.70 indicates Kellogg’s stock moves perfectly with the market index.
b. Estimate Kellogg’s cost of equity capital.
Round answer to one decimal place (ex: 0.0245 = 2.5%).