One of your new employees notes that your debt has a lower cost of capital (7%) than your equity (15%). So, he suggests that the firm swap its capital structure from 29% debt and 71% equity to 71% debt and 29% equity instead. He estimates that after the swap, your cost of equity would be 18%. a. What would be your new cost of debt? Make your calculations based on your firm's pre-tax WACC. b. Have you lowered your overall cost of capital? a. The new cost of debt is%. (Round to two decimal places.) b. Have you lowered your overall cost of capital? (Select the best answer below.) O A. No, because your overall cost of capital (WACC) is determined by the risk of your assets. O B. Yes, because your overall cost of capital (WACC) is not determined by the risk of your assets. O C. Yes, because your overall cost of capital (WACC) is determined by the risk of your assets. OD. No, because your overall cost of capital (WACC) is not determined by the risk of your assets.
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.
Subject:- finance
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