Question

You have been assigned to estimate the cost of capital of Merck &Co based solely on the
available information. Merck is a pharmaceutical company that develops and manufactures and
markets medicines therapies and consumer and animal products. For the fiscal year end
December 31, 2009, Merck had the following balance sheet information:
(in millions)
Loans payable and current portion of long-term
debt 1,379.20
Trade accounts payable 2,236.90
Income tax payable 9,453.80
Dividends payable 1,189
6% mandatory convertible preferred stock, $1 par 206.60
Total current liabilities 15,750.70
Long-term debt 16,074.90
Deferred income tax and non-current liabilities 18,771.50
Common stock, $0.5 par value 1,781.30
Other paid in capital 39,682.60
Retained earnings 41,404.90
Accumulated other comprehensive loss -2,766.50
Stockholders' equity before deduction for treasury 21,044.30
Total stockholders' equity 59,058
Other information:
1. The market value per share of Merck common stock is $36.2 at the end of 2010.
2. The beta of the common stock of Merck is 0.66.
3. Merck debt is rated AA by S&P and Aa3 by Moody’s.
4. The yield on Merck’s long-term debt at the end of 2010 ranges from 4.099 to 5.243
percent. Merck’s long-term debt trades for values ranging from 98.165 to 118.660.
5. At the end of 2010, the rate on a 10-year Treasury bond is 3.48 percent.
6. The expected market risk premium is in the range of 2.5 to 4 percent.
7. The anticipated dividend for 2011 is $1.52 per share.
8. The retention rate for Merck is typically 50 percent.
9. The annual rate on equity for 2010 and 2011 is anticipated to be 20%.
Using the fiscal year 2009 balance sheet information for your best guide to the company’s target
capital structure for future years, estimate Merck’s weighted cost of capital as of the end of
2010. Be sure to list your assumptions and support your choices.

Answer 1

Answer:

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