Question

You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt is 9 percent, while the cost of equity is 19 percent. What is the overall cost of capital for the firm?

Answer 1

15.00 %

Step-by-step explanation:

The cost of capital for the firm is the return that is required by the providers of long term permanent sources of finance. Such as equity and debt. Thus cost of capital works on the premise of Pooling of Funds and the thus the Cost of the Capital should be on a Weighted Average of all costs of the long term permanent sources of finance.

Weight of Equity = $300 ÷ ($300 + $200)

= 0.6

Weighted Cost of Equity = 19.00 % × 0.6

= 11.40 %

Weight of Debt = $200 ÷ ($300 + $200)

= 0.4

Weighted Cost of Equity = 9.00 % × 0.4

= 3.60 %

Therefore,

Cost of capital for the firm = 11.40 % + 3.60 %

= 15.00 %