Question

Question 23 The total capital of Griffith Telecom is 75 million AUD and of this total capital, 40 million AUD is the equity capital. The cost of debt is 2.5% while the cost of equity is not known. According to your analysis the risk-free rate is 1.2%, the expected market return is 6%, and the company’s beta is 1.3. The company’s tax rate is 25%. Task: The company’s CFO instructed you to estimate the cost of company’s equity and the total cost of company’s capital based on what you have learnt in International Finance course that you have taken at Griffith. Provide all the workings (use up to 3 decimal places).

Answer 1

Total capital = 75M AUD, Equity capital = 40M AUD; hence debt capital = 75 - 40 = 35M AUD

Cost of debt = 2.5%, Tax rate = 25%

Cost of equity per CAPM = risk free rate + beta * (expected market return - risk free rate) = 1.2% + 1.3 * (6% - 1.2%) = 1.2% + 6.240% = 7.440%

Total cost of capital = (debt / total capital) * cost of debt * (1-tax rate) + (equity / total capital) * cost of equity

= (35 / 75) * 2.5% * (1 - 25%) + (40 / 75) * 7.440% = 0.875% + 3.968% = 4.843%