Answer: The cost of capital is 9.2%
Explanation:
Given:
Common stock = $40 million
Market value = $60 million
Beta = 0.8
Market risk premium = 10%
Treasury bill rate = 6%
Here , we'll use the following formula to evaluate the firm's cost of capital:
Cost of capital = (Cost of debt × Weight of debt) + (Cost of equity × Weight of equity)
∵ Cost of equity = Risk - Rate + (Beta × Premium)
Cost of equity = 6 + (0.8×10)
Cost of equity = 0.14
Cost of equity = 14%
∵ Weight of equity = [tex]\frac{Total\ equity}{Total\ debt + Total\ Equity}[/tex]
Weight of equity = [tex]\frac{40}{60 + 40}[/tex]
Weight of equity = 0.40
∵ Weight of debt = [tex]\frac{Total\ debt}{Total\ debt + Total\ Equity}[/tex]
Weight of debt = [tex]\frac{60}{60 + 40}[/tex]
Weight of debt = 0.60
Putting these three variable in the above given equation:
Cost of capital = (6×0.60) + (14×0.40)
Cost of capital = 0.36 + 0.56
∴ Cost of capital = 0.092
∴ Cost of capital = 9.2%
