ul analysis, Excellence Berhad has determined its optimal capital structure as shown in the following table. Source of capital Target market value weight Long-term debt 30% Preference share 15% Ordinary share 55% Total 100% The cost of debt is estimated to be 7.2%; the cost of preference share is estimated to be 13.5%, the cost of retained earnings is estimated to be 16%; and the cost of new ordinary share is estimated to be 18%. All of these are after-tax rates. Excellence Berhad expects to have a significant amount of retained earnings available and does not intend to sell any
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.
After careful analysis, Excellence Berhad has determined its optimal capital structure as shown in the following table. Source of capital Target market value weight Long-term debt 30%
Trending now
This is a popular solution!
Step by step
Solved in 3 steps
