Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
6. What is the
7. The weighted average cost of capital for CS1 is
8. The weighted average cost of capital for CS3 is
9. What is the weight of equity in the optimal capital structure
10. What is the weighted average cost of capital on the optimal capital structure?
![Ron Inc., who has an applicable 30% corporate tax as stated on its BIR tax registration form, is trying to determine its
optimal capital structure. The company's capital structure consists of bonds and common stock. The following are the
Capital Structure options:
Capital Structure
options
Debt to Equity
Before-tax
Equity Ratio
Ratio
cost of debt
Cs1
60%
67%
7.50%
CS2
50%
100%
8.50%
CS3
45%
122%
9.00%
The company uses the CAPM to estimate its cost of ordinary or common equity. Ron Inc. estimates that its beta would
be 1.0 if it has no debt. The risk-free rate is 3% and the market rate of return on average stock market is 8%.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fee173d2c-636f-4cb5-a8c3-bb77ad1e2c14%2F40649ec5-a247-45f4-8e58-51ab0a5145d9%2Fobyiimb_processed.png&w=3840&q=75)
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