Simple Tech Inc is an Australian company operating in a pure imputation tax system. It is currently financed entirely (100%) by equity and has a beta of 0.8. After examining its capital structure, Simple Tech finds that the optimal capital structure can be achieved at D/E ratio of 0.4. The before- tax cost of debt capital for Simple Tech at the optimal capital structure is 10% p.a. The risk-free rate and market risk premium are 5% p.a. and 7% p.a., respectively. If the statutory corporate tax rate is 30%, which of the following is closest to the cost of equity at the optimal capital structure (using the approach covered in the lecture)? O 12.03% p.a. O 12.84% p.a.
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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