Final answer:
The company's cost of capital is 13%, calculated using the Weighted Average Cost of Capital (WACC) formula, which takes into account the proportions and costs of the company's equity and debt financing.
Step-by-step explanation:
Cost of Capital:
The company's cost of capital can be calculated by using the Weighted Average Cost of Capital (WACC) formula, which considers the proportion of equity and debt and their respective costs. However, as there are no taxes mentioned, the cost of the debt will be the risk-free rate, which is the Treasury bill rate. The cost of equity can be computed by using the Capital Asset Pricing Model (CAPM).
The formula for the cost of equity using CAPM is: Cost of Equity = Risk-Free Rate + (Beta × Market Risk Premium) Substituting values, we get: Cost of Equity = 5% + (1.25 × 8%) = 5% + 10% = 15% Since the company is financed by equity ($20 million) and risk-free debt ($5 million), the total value of financing is $25 million. The equity proportion is 80% ($20 million / $25 million) and the debt proportion is 20% ($5 million / $25 million). The WACC is calculated as follows: WACC = (Equity Proportion × Cost of Equity) + (Debt Proportion × Cost of Debt) WACC = (0.80 × 15%) + (0.20 × 5%) WACC = 12% + 1% WACC = 13%