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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 capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm

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cecepham

Answer:

Kc = = 0.054 + 0.076 x (1-t)

The overall cost of capital for the firm is 13%

Explanation:

We have the formula to calculate the overall cost for the firm as following:

[tex]k_{c} = \frac{E}{E+D}k_{e} + \frac{D}{E+D} k_{d} (1-t)[/tex]

In which:

  • Kc: the overall cost of capital
  • Ke: the cost of equity capital => Ke = 19% = 0.19
  • Kd: the cost of debt capital => kd = 9% = 0.09
  • E: total equity => E = $300 million
  • D: total debt => D = $200 million
  • t: revenue tax of firm

So that, the overall cost of capital for the firm is:

Kc = [tex]\frac{300 million}{200 million + 300 million}* 0.09 + \frac{200 million}{200 million + 300 million}*0.19*(1-t)[/tex]

= 0.054 + 0.076 x (1-t)

As the revenue tax for firm is not give, assume that t = 0

=> Kc = 0.13

=> The overall cost of capital for the firm is 13%

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