Question

1) Suppose you borrow $800000 when financing a coffee shop which is valued at $1958500. You expect to generate a cash flow of $2200000 at the end of the year. The cost of debt is 8%. What should the value of the equity be?

2) Suppose you borrow $800000 when financing a coffee shop which is valued at $1958500. You expect to generate a cash flow of $2200000 at the end of the year. The cost of debt is 8%. What is the cost of equity?

Answer 1

1)

value of equity   = Total value of coffee shop - value of debt

                                                      = $1958500 - 800000 = $1158500

2)

weight of equity = 1158500/1958500 = 2317/3917

let x be cost of capital

=>

1958500 = 2200000/(1+x)

=>

x = 12.33%

=>

12.33% = 2317/3917 * cost of equity + 1600/3917 * 8%

=>

cost of equity . = 15.32%