Peter's Pet Foods has a WACC of 12.5 percent and is considering manufacturing pet toys. Tim's Toys specializes in pet toys and has a WACC of 10.5 percent. What discount rate should Peter's Pet Foods use to evaluate this investment? 10.5 percent because that is appropriate given the risk of the project The risk-free rate. A weighted average of 12.5 and 10.5 with the weights based on the proportion in each business 11.5 percent because after investment Peter's will be a combination of the two businesses 12.5 percent because that is the appropriate rate for the company
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.
Peter's Pet Foods has a WACC of 12.5 percent and is considering manufacturing pet toys. Tim's Toys specializes in pet toys and has a WACC of 10.5 percent. What discount rate should Peter's Pet Foods use to evaluate this investment?
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10.5 percent because that is appropriate given the risk of the project
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The risk-free rate.
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A weighted average of 12.5 and 10.5 with the weights based on the proportion in each business
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11.5 percent because after investment Peter's will be a combination of the two businesses
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12.5 percent because that is the appropriate rate for the company
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