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.
Apex Industries Ltd. (AIL) asked you to find the required
Beta of the company’s equity is 1.5; Debt to value ratio of the company is 50%; Market risk premium is 8% (expected return of market portfolio minus risk-free rate), risk-free rate is 6%,
The company’s cost of debt is 10% and its corporate tax rate is 30%.
AIL wants to finance the project with a debt to value ratio of 40%. It can borrow at 8% interest rate and its corporate tax rate is also 30%.
1. Find out the required rate of return, i.e. RWACC, that AIL wants to use as the discount rate to find out the
2. AIL is a conglomerate. Its current RWACC is 14%. Explain why AIL cannot use this RWACC as the discount rate to find out the NPV of the proposed project
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