You are trying to estimate the cost of capital for Polo Ralph Lauren (PRL), an upscale specialty retailer

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You are trying to estimate the cost of capital for Polo Ralph Lauren (PRL), an upscale specialty retailer. The firm is in only one business, specialty retailing; comparable firms have an average published beta of 1.20, an average debt ratio of 30% and an average tax rate of 35%. The firm has provided you with the following information:

The regression beta is 0.75 with a standard error of 0.5.

The firm’s bonds are rated A, and the default spread for A rated bond is 1%. The company plans to maintain its current debt ratio of 25%.

The Treasury bond rate is 2.5% and the market risk premium is 6.5%.

The tax rate for PRL is 40%.

a)     Estimate PRL’s beta based upon the comparable firms (i.e. Bottom up beta)   

b)     Estimate the range for the regression beta at a 95% confidence interval

c)     Which beta estimate (regression or bottom-up) do you use and why?      

d)     Estimate the cost of equity for the firm                                        

e)     Estimate the cost of debt for the firm                                                                   

f)      Estimate the cost of capital (WACC) for the firm