a. What is Ambeon's weighted average cost of capital? b. If Ambeon's stock price were to rise such that it sold at 1.7 times book value, causing the cost of equity to fall to 12 percent, what would the firm's cost of capital be (assuming the cost of debt and tax rate do not change)? c. Ambeon is considering a new business opportunity involving the acquisition of a trucking firm. What do you think the firm should do to select an appro- priate cost of capital for evaluating this acquisition? (Note: This is a thought exercise. No calculations required.)
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.
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