) is one half. The company has $2.5 billion in face value of perpetual bonds which pay an annual coupon of 4% and have a yield to maturity of 10%. ABC’s equity has a beta of 1.25. The company faces a 35% tax rate. The risk-free rate of return is 5.6% and the market risk premium, over and above the risk-free rate, is 8%. The company is considering a business expansion in the retail i
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.
You are Chief Financial Officer of the ABC Corporation. ABC has two divisions, one of which is retail, and the other is manufacturing.
ABC’s debt-equity ratio (measured at market value) is one half. The company has $2.5 billion in face
The risk-free
The company is considering a business expansion in the retail industry. The expansion project will generate $20 million
Companies that operate purely in the manufacturing industry have an average beta of 0.8 and an average debt-equity ratio (measured at market value) of three quarter.
Companies that operate purely in the retail industry have an average beta of 1.8 and an average debt-equity ratio (measured at market value) of one quarter.
What is ABC’s weighted average cost of capital (WACC) for the capacity expansion project?
| a. |
9.6% |
|
| b. |
15.0% |
|
| c. |
17.3% |
|
| d. |
12.6% |
|
| e. |
13.0% |
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