Answer:
The company's cost of capital is 8%
Explanation:
With the given information, we can calculate company's cost of equity by Capital Asset Pricing Model (CAPM) = risk free rate of return + beta * (market rate of return – risk free rate of return), in which risk free rate of return is Treasur bill rate which is backed up by government then free risk
Cost of equity (CAPM) = 5% + 1.25*(8%-5%) = 8.75%
Cost of debt = interest rate of debt * (1 – tax rate) = 5%*(1-0) = 5%
Cost of capital = cost of debt * its portion in total debt & equity + cost of equital * its portion in total debt & equity
= 5%*($5 million/ $25 million)+ 8.75% * ($20 million/ $25 million) = 8%
