Question

1. ABC inc. a listed entity wants to build a sports stadium worth $ 1 million for its local county. ABC inc. raises $ 500,000 via debt issue at a post tax cost of debt of 5%. The firm also raises $ 300,000 via equity issues. The remaining $ 200,000 is raised via donation by the community patrons. If the risk-free rate is 5%, ABC’s beta is 1.2, market risk premium is 5% and tax rate is 30%, estimate the cost of capital for building the sports stadium.

Answer 1

Weighted Avg Cost of Capital = We*Ke+ Wd*Kd+ Wdb*Kdb

We= Weight for Equity Shares

Ke= Cost of Capital of Equity

Wd=Weight for Donation

Kd = Cost of Capital of Donation

Wdb=Weight for Debt

Kdb= Cost of Capital of Debt

Cost of equity = Risk free rate of return + Beta × (market rate of return – risk free rate of return)

=5%+1.2*5%

=11%

Cost of Debt = Interest Expense (1 – Tax Rate)

=5%*(1-.30)

=3.5%

Weighted Avg Cost of Capital = We*Ke+ Wd*Kd+ Wdb*Kdb

=2,00,000/10,00,000*11%+3,00,000/10,00,000*0%+5,00,000/10,00,000*3.5%

=3.95%