Question

A company is trying to determine the cost of capital for a major expansion project. A survey of commercial lenders indicates that cost of debt is currently 8% based on the company's debt ratio of 40%. The company complies with this requirement and has determined that a stock issuance would require a 10% return in order to attract investors.

Which of the following is the company's cost of capital?

A) 8.8%

B) 9.2%

C) 10.6%

D) 18.0%

Answer 1

Weigheted Average cost of Capital = (Weight of Equity x Cost of Equity ) +( Weight of Debt x Cost of Debt)

here,

Weight of Equity =0.6

Cost of Equity =10%

Weight of Debt = 0.4

Cost of Debt =8%

Substituting values in the equation we get

Weigheted Average cost of Capital = (Weight of Equity x Cost of Equity ) +( Weight of Debt x Cost of Debt)

Weigheted Average cost of Capital = (0.6 x 0.1) + (0.4 x 0.08)

Weigheted Average cost of Capital = 0.06 + 0.032

Weigheted Average cost of Capital = 0.092

Weigheted Average cost of Capital = 9.2%

So the companys cost of capital is 9.2%