The firm's cost of debt is 9 percent, and the cost of retained earnings is 15 percent. However, if the firm exhausts its retained earnings of $236,780, the cost of equity rises to 15.9 percent. Currently management believes that the firm's current combination of 35 percent debt and 65 percent equity is the optimal capital structure. a. What is the firm's cost of capital if it uses only retained earnings? b. What is the firm's cost of capital if it uses new equity? c. How much total financing may the firm have before the marginal cost of capital rises?
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.
The firm's cost of debt is 9 percent, and the cost of
a. What is the firm's cost of capital if it uses only retained earnings?
b. What is the firm's cost of capital if it uses new equity?
c. How much total financing may the firm have before the marginal cost of capital rises?
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