Question

# a company's total assets \$10000 last year, liabilities \$4500. at that time the interest are is...

a company's total assets \$10000 last year, liabilities \$4500. at that time the interest are is 12% and tax rate 20 and capital cost is 16%. the company plans to issue bonds for the following year so that the debt ratio will increase by 10% compared to last year. if, for example, debt investors and capital investors ask for a risk premium of 2% each compared to last year, calculate the size of the company's capital costs the following year

Solution:

Total Assets = Equity + liabilities

\$ 10000 = Equity + \$ 4500

Equity = \$ 5500

Cost of equity presently (ke) is

(0.45 * 12 * 0.8 ) + (0.55 * ke) = 16

4.32 + 0.55ke = 16

Ke = 11.68 / 0.55

Ke = 23.23 %

Company capital cost the following year be X.

Then

X = 5500 + 0.55*X

X - 0.55X = 5500

X = 5500 / 0.45

X = \$ 12,222.22

Size of company's cost of capital is \$ 12,222.22

Issue size of bonds size is \$ 2,222.22

Cost of capital the following year

=(0.55 * 14 * 0.8 ) + (0.45 * 23.23)

= 16.61%