Final answer:
The company's cost of capital is calculated as the weighted average of the cost of equity and the cost of debt based on their proportions of the total financing. After computations, the cost of capital comes out to be 10.5%.
Step-by-step explanation:
To calculate the company's cost of capital, we must weight the cost of equity and the cost of debt by their respective percentages in the company's overall financing structure. The market value of the company's equity is $15 million, accounting for 75% of the total financing ($15 million out of $20 million total, with $5 million in debt). The cost of equity is given as 12%. Similarly, the company's debt is $5 million, which represents 25% of the company's total financing. The cost of debt is given as 6%.
Now we multiply each portion by its respective cost and sum them up:
- Cost of Equity: $15 million / $20 million × 12% = 0.75 × 12% = 9%
- Cost of Debt: $5 million / $20 million × 6% = 0.25 × 6% = 1.5%
The company's combined weighted average cost of capital (WACC) is the sum of these two figures:
WACC = Cost of Equity (9%) + Cost of Debt (1.5%) = 10.5%